The financial system has reached the point of maximum peril. After years of profligacy, banks have all but stopped lending to each other as the US Congress decides whether to extend support. If the unravelling of the banking system continues, the economic consequences will be dire. Yet there is an even greater risk: that the politicians now contemplating Wall Street’s follies draw the wrong conclusions and take the wrong decisions, losing their confidence in markets altogether.
It would not be the first time. After the Wall Street Crash, markets were deemed to have failed and US lawmakers attempted to regulate short-cuts through the crisis. The widely-copied Smoot-Hawley Tariff Act quadrupled the effective tax rate on thousands of imports and deepened the “Great Contraction” of 1929 to 1933. The price of popular anti-market sentiment was much higher in some of Europe’s fledgling democracies: fascism.
Despite the severity of the current crisis, such extreme reactions remain very unlikely. Yet there is plenty of room for policymakers to compound the damage already inflicted by the irresponsible conduct of the financial sector. It is time, then, to remember what open markets have achieved, and what lies in wait for societies that suppress them.
It is no help that some of the loudest critics have little interest in what went wrong, less in how to fix it, and none at all in safeguarding against problems in future.
The current crisis is routinely described as a symptom of deregulation, but it is equally the child of earlier, ill-fated interventions. Subprime mortgages grew because the prime mortgage sector was dominated by Fannie Mae and Freddie Mac, two institutions founded, regulated and effectively underwritten by the government.
Capital markets clearly need better regulation but policymakers should guard against unintended consequences. Markets are places of trial and, very frequently, error. Their genius is not perfect efficiency, but the rewarding of success and the weeding out of failure. No better alternative has ever presented itself.
This is a difficult time to defend free markets. Nevertheless they must be defended, not only on their matchless record when it comes to raising living standards, but on the maxim that it is wise to let adults exercise their own judgment.
Market freedom is not a “fundamentalist religion”. It is a mechanism, not an ideology, and one that has proved its value again and again over the past 200 years. The Financial Times is proud to defend it – even today.
Sunday, September 28, 2008
"In Praise of Free Markets"
If you missed it, this editorial from The Financial Times last week is worth reading, "In Praise of Free Markets". Here are a few excerpts: