Free Markets, Free People

Free Market Bashing

Since the inception of the current downturn, free market capitalism has taken quite the bashing. Supporters of significant government involvement in the economy deride the horrors of “unfettered capitalism” and a “free market run amuck.” Frequently, deregulation of capital markets is singled out as the most dastardly culprit, to which Pres. Obama seems to be alluding when he blames “relying on the worn-out dogmas of the past,” and “too little regulatory scrutiny.” Yet, after the last eight years in which we witnessed Sarbanes-Oxley, No Child Left Behind, Medicare Part D, and numerous attempts to reign in Fannie Mae and Freddie Mac shoved aside by legislators, evidence of unregulated economic activity being the source of our crisis seems rather scant.

The idea that “deregulation” was somehow responsible for the mortgage meltdown is a particularly shaky proposition. Shannon Love explains why:

Leftists have to answer a question: if greedy, irresponsible, unregulated etc. capitalism caused the housing bubble, why didn’t we see a similar bubble in commercial real-estate markets which operate under even less regulation than the residential markets? Why does the politically neglected and unregulated commercial real-estate market exhibit much milder swings?

[...]

The differences between residential and commercial real estate provide the means to test the hypothesis that government intervention or the lack thereof caused the housing bubble and subsequent collapse of the financial system. We can compare the two markets because the same institutions ultimately make residential and commercial loans. They make loans in the same communities and regions. Changes in the economy affect both types of real estate at the same time and to the same rough degree. The only major difference between the two markets lies in the degree of government intervention.

After dispensing with some obvious questions about the comparison, Love highlights how the residential market was essentially turned into a Lemon’s Market:

More than any other policy, the creation of Freddie Mac and Fanny May distorted the residential mortgage market in a way that the commercial market escaped. The FMs exist solely to induce lenders to make residential loans that the free market judged too risky. The FMs buy up residential mortgages from primary lenders and bundle them together in securities. They do so precisely in order to short-circuit the free-market feedback system that communicates to banks when the financial system as a whole has lent out as much money as it safely can. That feedback system worked like a governor on an engine. It kept the system from running away and lending more money than it could recoup, but also prevented people with poorer credit from getting loans.

Politicians who wanted the engine to run faster created the FMs to bypass the governor in order to get higher performance in the short run. Since the FMs would buy up almost any mortgage, lenders could make riskier and riskier loans without suffering any negative consequence. The FMs replaced the self-interested secondary-market buyers with people playing with government money and a mandate to induce more and more lending. Special dodgy accounting rules allowed the FMs to hide the risk behind the securitized mortgages they sold.

Deregulation caused the residential mortgage meltdown?

Deregulation caused the residential mortgage meltdown?

As Love points out, the commercial real estate market has no such mechanism muddying its waters, and information is comparatively less asymmetric. Without the government interference, commercial mortgage lenders let the potential for bad outcomes drive their decision making:

Tellingly, no such intervention occurred in commercial markets. The FMs’ charters expressly prevented them from buying commercial mortgages. As a result, the commercial mortgage market functioned with a free-market governor. When lenders made too many risky loans, free-market secondary buyers stopped buying their mortgages and the system cooled down. As a result, commercial markets saw no runaway boom and subsequent colossal bust.

Although I think that laying the crisis solely at the feet of the residential mortgage market is overly simplistic (for example, what was up with the ratings agencies?), Love does point to a very apt comparison as to how government intervention in the market changes incentives and behavior. If you guarantee risks against bad loans, and subsidize the debtors, then more of such loans will be made. Remove such a guarantees and subsidies and market forces will severely punish improperly compensated risk taking.

The trade off, of course, is that free markets do not allow much opportunity for rent-seeking. Which is why Love’s final lament is so true:

Sadly, experience suggests that mere empiricism has no place in political economics.

That’s because empiricism does not buy votes.

8 Responses to Free Market Bashing

  • If the State-humpers and government-fellators who are now (in the words of “the Daily Gut’s” Greg Gutfeld) “trying to use the financial crisis the way looters used the Rodney King verdict–as an excuse for a smash-and-grab” were honest about their agenda, they’d admit that what they most  dislike about the “runaway free market” is the “free” part.

  • Great points.

    It would be interesting to see a graph of commercial vs residential sales, % up and down for the last couple of decades.

  • Free markets are taking such a bashing this is the first pretty bad downturn we’ve faced in about 30 years, and the whiny, selfish wussed-up nation that we are is collectively losing our minds.  Someone who’s never been been hurt wails the loudest when they get a little knee scrape. We can’t get what we want the second we want it, so we have to destroy the system! Booooo! Evil system. And the professional stalinists on the left gladly egg it on.

    Losers. Wusses.

    Toughen up, people.

  • if the media and the Campaigner in Chief would just shut the hell up the 93% who are still  employed would quit worrying about the future and continue with life as usual and keep buying cars and big screen tvs.  Instead we’ve got the Campaigner in Chief telling the world how we are headed for disaster if we don’t jump on his band wagon and support the dumocrap spending spree.

  • Michael, you simply have to face the fact that the Republican way to run the economy has failed. I decree it. Not surprisingly, since Republicans are such dolts. And mean ones too. And since the Bush regime is over (finally!), that’s all behind us as we are lead by Obama. I look at his Christlike visage every day, and I’m so inspired that I’m energized to continue working on my new book “Why is War Easy? Because Dense Righties Like It.”

    And of course, we all know that “Republican governance” is exactly the same thing as “free market capitalism,” so therefore the free market has failed too. Those greedy businessmen just can’t be trusted to make decisions that are in the best interests of the state, er, I mean society. So wise politicians and bureaucrats must make the investment decisions for the whole country. And that’s not a thing like German in the 1930s and 1940s, so stop saying that! It’s an insult to the German people anyway, and I’m an expert on Germany, and I can tell you that it’s a great country, except that I can’t seem to find any good bagles or lox there. (I’ve never figured out why that it is, but I’ve just learned to accept it.)

    Those greedy businessmen created this horrible bubble just to take advantage of poor, innocent people by loaning them money that couldn’t be paid back. And why someone greedy would basically give money away that they don’t expect to get back is a complex, political-sciencey thing that you would never understand. But it’s not government’s fault! Oh, no! It had absolutely nothing to do with governmental meddling in the mortgage market or threats to punish institutions that didn’t load more to poor people, so you really, really ought to stop saying that.

    Just relax, and accept the wise leftists’ take that it was all the fault of Bush and the Republicans, even the stuff that Clinton did. Then you can rest in the assurance of the righteousness of postmodern leftism, in which there is no guilt or shame. It’s nirvana, Michael. You should try it.

  • sharkFree markets are taking such a bashing this is the first pretty bad downturn we’ve faced in about 30 years, and the whiny, selfish wussed-up nation that we are is collectively losing our minds.

    Yep.  O’ course, this collective losing our minds is aided and abetted by the dems (spit) and MiniTru, who see economic crises as golden opportunities (sort of like the gleeful chuckling they did when the hurricanes hit the Gulf Coast last year).  The problem is that people have short memories and are generally ignorant.  The dem’s (spit) mantra that the economy in ’04 was “The Worst Economy Since the Great Depression” (TM), along with their looney assertion that OIF is “The Most Mismanaged War in History” (TM), is laughable to anybody who knows or remembers even a little bit about our history.  Unfortunately, that seems to be a small minority of our people.  democrats (spit) rely on the ignorant, the fearful, the jealous, and the stupid as their most secure voting base.

    macif the media and the Campaigner in Chief would just shut the hell up the 93% who are still  employed would quit worrying about the future and continue with life as usual and keep buying cars and big screen tvs.  Instead we’ve got the Campaigner in Chief telling the world how we are headed for disaster if we don’t jump on his band wagon and support the dumocrap spending spree.

    I think that there is a lot of truth in this.  Economic downturns are real, of course, but they can be made a helluva lot worse by Chicken Littles who react to a decline in the stock market or an increase in unemployment with hysterical cries that the world is coming to an end.  If MiniTru was even remotely unbiased, they’d quickly expose TAO and the democrats for the dishonest alarmists that they are.  Unfortunately, MiniTru is not about truth, but rather about furthering the democrat (spit) political agenda.

  • The free market has been a concept in theory only.
    In practice, there is hardly and free market left in the US
    That’s why…when oil prices go up…the price at the pump goes UP
    and when oil prices are down…the price at the pump goes UP.

    That old mantra of “Drill, baby drill”  was just an empty slogan.
    No way is Exxon  going to produce more oil and CUT it’s profit?