An essay appeared in the Wall Street Journal on March 1st, 2010, entitled “Why Financial Reform is Stalled,” by Peter J. Wallison, a Senior Fellow at the American Enterprise Institute. The article blames all of the financial failure of 2007 – 2010 upon moral hazard, and argues that the government never should have bailed out the crumbling banks, because this only furthered moral hazard. A very neat analysis that ignored the fact that something had to be wrong in the first place for the moral hazard to have been created, and also that the consequences of this particular cure might have killed the patient.
Uh, Mr. Wallison, you forgot to tell us why the crisis happened. I agree that the crew in the White House and most of Washington are statists, and that their cures are often worse than the disease. But how do you expect us to believe that wrong-headed solutions caused a crisis that had already occurred months before? And do you really think that the crisis would have been averted if we simply had less regulation of the banking sector?
Contrary to your assertion, life would not have returned to normal if the Fed and Treasury had done nothing when Lehman failed. The chain reaction was already in progress: Morgan Stanley and Merrill were both on the brink. The whole banking sector seized up—as it would have done if Bear Stearns had simply been allowed to go bankrupt back in March. Statism is a huge problem, but that doesn’t mean that pure laissez-faire will cure all problems. To make such a bald assertion risks impugning the whole cause of conservatism in the United States.
Several readers responded to my entry by simply denying that there ever was a crisis, that the Lehman bankruptcy did not cause counterparty failure, and that if the Federal Government had not intervened, everything would be back to normal. Several likened their idea of an appropriate response to ripping off a Band-Aid quickly, rather than trying to lessen the pain by pulling it off one hair at a time. A more dangerous misconception than this, I could scarcely imagine, and after reading about fifty more responses to the thread, most of which said in essence, “just get the Government off our backs,” I couldn’t stand this mindlessness any longer:
You radical libertarians are the mirror image of the true-believer Communists, who all swore that if Marxian socialism were just given ONE more chance—one REAL chance—without the corruptions of [insert the name of the latest loused-up social disaster here] it would all be shown to work, and to be the best political system ever devised. . . . Give us a break! The mirror image of chaos isn’t perfection, it’s rearranged chaos. A ‘perfect’ free market is not going to work any better than a ‘perfect’ centrally-planned economy will work. You all think that if we had just been wiling to rip the Band-Aid off a little faster, life would be hunky-dory by now. It wouldn’t, and you’d be out of work, too. And you and you and you and you and you . . .
Until you realize that there is no lower limit to the misery into which an economy can sink, until you realize that if you want to play roulette with someone else’s life, they are just as happy to play roulette with yours, until you realize that failed banks, repossessed homes, and crushed pension accounts are not statistical abstractions but real lives, ruined possibly forever, you will continue to prescribe this eighteenth-century snake oil that kills otherwise potentially save-able patients. Any such deaths should be on your heads.
The financial system failed because too much of it was dedicated to making speculative returns for its own practitioners. It was no longer producing a good product for those who needed it, but was dedicating more and more of its resources to enriching itself through dealings only with itself. Yes, federal insistence upon making mortgages available to anyone, no matter how impoverished or otherwise unfit, provided the basis upon which the actual disaster was jerry-rigged and that was unbelievably stupid. It provided the proximate stimulus for the disaster this time. But it was the go-go financial services industry that gleefully provided the means by which the scaffolding was piled so high; otherwise the real-estate bubble never could have been funded. And the engine that made the financial services industry so self-serving and risk-seeking was not stoked from outside; it was stoked by the pure, simple, very human greed of those within the industry. The same greed that rabid Ayn Randians exalt as the best human motivator. Greed of which any of us and all of us are capable. You put a money machine in any of our hands, and it will rapidly go to our heads, destroy our judgment, and lead to the next economic bubble. That is human nature, and we are stuck with it.
The solution to the abdication of regulatory responsibility that made this crash inevitable sooner or later is not to further reduce regulation, it is to make it better and where it is needed, stronger. Not necessarily more of it, because much of the current regulation is useless and ill-designed, and adds unnecessary costs. But better regulation, specifically designed to re-focus this service industry (for that is all it is) upon the services it provides to its ultimate clients: corporate borrowers, issuers, and savers. Big financial conglomerates will not of themselves do what is right; they will do whatever maximizes their returns within their existing framework, and over a relatively short time frame. The free market, which depends upon constant feedback from all of its participants, will not naturally foresee and correct what lies beyond its time horizon. Yet most of us involved in the industry knew instinctively that the colossal framework that had developed in and because of derivatives was mostly artificial, economically unproductive, made too many disparate financial entities too interconnected, and was ultimately balanced on the head of a pin. It took naive belief in the perpetual rightness of free markets to let it go its merry way, happily growing of its own accord, until something underneath it was yanked away and the whole edifice started to collapse.
Now you are telling us that no one should have tried to catch any of the pieces, to prop up what was still wavering, not even to pull any survivors out of the wreckage. Let the chips fall where they may, and keep the government out of the business of backstopping financial losers, even those central to the financial system. Just as, I suppose, the “solution” to the earthquake disasters in Haiti and Chile would be to let the victims there die, and eventually any survivors will move somewhere where there are no earthquakes—yet. (But not the U.S., of course, because we will protect our borders. Of course, so will everyone else.) This is what Social Darwinism would require.
Has anyone out there ever heard of the Golden Mean? The possibility of steering between two excesses? That without creating a ‘nanny state’ we just might want to have some prudential regulation, to keep card sharps from stealing too much from the naive and unwary, and to keep a fad from diverting so many resources that there is nothing left for the necessary functions of life? Just a thought you might want to ponder before you pick up your copy of Atlas Shrugged to look for the old answers to new problems.