Wednesday, October 1, 2008

Thought on the Crisis

It’s becoming pretty obvious that the people who are going to have to legislate a solution to the current crisis are either very simplistic in their understanding of a complex system, or are pandering to people who are. More likely a combination of both.

There are two opposing and extreme viewpoints that I seem to be hearing a lot of. The first is that government can dictate financial activity effectively, and the second is that the free market must be allowed to work.

In the first instance, we have a complete denial of the unintended consequences that can flow from rash action, examples of which are abundant in recent financial news. The second is based upon the fallacy that a free market currently exists.

Free markets are economic models. They are useful for predicting things in certain situations, but they don’t actually exist in the real world. And even the most hardcore libertarian wouldn’t want them. There are markets which exhibit different degrees of freedom or political control, but there are no truly free markets.

When you introduce rules into a marketplace, they will affect different people or entities differently. It’s at this point that you have to begin to make value judgements on the fairness of these rules. And so I believe that you absolutely do have to balance the interests of those who will be affected by the externalities of this crisis against the impulse to let the institutions that got us here simply fail.

With that said, handing over $700 billion dollars to an official of the same administration that told us to trust it on Iraq because we couldn’t wait for more evidence seems like pure insanity. The moral hazard, precedent, and transformation of the financial system that this “solution” will precede is not something that we should rush. Senator Barney Frank’s pronouncement that we don’t have time to debate whether it’s good or bad is an example of the worst kind of leadership. We do have time, and we must.

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