Were The Market To Blame For 2008?
I am not an anti-academic person, but there are times when people who have attained a certain level in academia make statements that are so completely incorrect, they must be called out.
Dani Rodrik, a Professor of Political Economy at Harvard University’s John F. Kennedy School of Government and the author of “One Economics, Many Recipes: Globalization, Institutions, and Economic Growth” recently had an article published that stated the following, I’m quoting:
“Markets must be deeply embedded in systems of governance. The idea that markets are self-regulating received a mortal blow in the recent financial crisis and should be buried once and for all. Markets require other social institutions to support them. They rely on courts, legal frameworks, and regulators to set and enforce rules. They depend on the stabilizing functions that central banks and countercyclical fiscal policy provide. They need the political buy-in that redistributive taxation, safety nets, and social insurance help generate. And all of this is true of global markets as well.”
This is a quotation from a Harvard Political Science professor as quoted in a recent issue of China Daily, of all places, a newspaper I read each day. This is one of seven guiding principles that this professor deems to be important as the future of the global economics plays out. I think his conclusive statements made within this article are incorrect though and I’d like to explore that.
“Self-regulating markets received a mortal blow and should be buried once and for all” is said with such assertiveness that it leads one to assume its accuracy, much like global warming or other “settled science”. I think however that this statement is not so correct and needs to be looked at further. The near catastrophe that was created resulting in the financial turmoil of the late 2000’s was not purely a function of self-regulating markets not working. Not at all! Rather this global situation was created by an intersection of big government, big business, and the consumer all coming together with a blind eye to create the mother of all bubbles.
The self-regulating markets can deal with this in that a freely operating market allows for bankruptcy and thus a cleaning out of the unwise leverage placed in a market. If the decisions made by institutions such as Bear Stearns, Lehman Brothers, Merrill Lynch and all the others were poor enough, they should have been allowed to go bankrupt thus wiping out shareholders, and in most cases debt holders as well. Yes, this is harsh medicine but it is the only way to prevent bigger disasters down the road. Similarly General Motors and Chrysler should have been allowed to go bankrupt thus letting a free market determine the real value of those enterprises. Only through accepting this very painful medicine do we create an environment that will make better decisions next time, and even deeply continue to protect our liberties. People it seems do learn from mistakes. But when mistakes are bailed out, the moral hazard of that same mistake being made again grows.
The macro problem with the notion of self-regulating markets not working only comes into play really with governments. Governments do not easily go bankrupt and re-set. Their equity holders are the citizens who pay the bills and historically, they have not taken it too well when their governments make poor enough decisions that those decisions lead to bankruptcy - look at Greece recently. However, if the truth is told, it is the citizen/shareholders that have allowed their governments to get out of hand thus creating the circumstances leading to a problem, much like a Board of Directors who let’s their company get out of hand. In the case of the late 2000’s problem, it was the citizens participating in this leverage binge that served at the root cause of the problem. No person was forced to take out a loan on a home they couldn’t afford. No one! But, because we had the government keeping interest rates so unsustainably low, and th