Tuesday, September 30, 2008

Banking Meltdowns, The Free Market and Bailouts

There's a very natural, almost visceral response to the difficulties of the big investment banks in the United States - 'you created the mess, you clean it up!'. Especially when one hears about the mind boggling salaries that the top executives get.

I have huge reservations about simply handing nearly a $1 Trillion dollars over to the banks as a 'bail out' package without some strings on it - both for oversight and to put in motion a process to examine what happened and restructure the marketplace to control that kind of risk better.

Banking has always struck me as a fairly staid, risk averse business. Perhaps at its core it is, but clearly the so-called "investment banks" have clearly been running towards risk in the name of profits.

I disagree substantially with this economist on a key point:

The fact that government bears such a huge responsibility for the current mess means any response should eliminate the conditions that created this situation in the first place, not attempt to fix bad government with more government.

My disagreement is simple - this is the classic line of the "Free Marketeer" (sounds surprisingly close to "Privateer" - an archaic term for Pirate, doesn't it). Basically his entire argument hinges on the idea that government intervention in the markets is "bad". He's wrong. Very wrong.

The problem here is very much that the government has not thought to draw out the lines of the 'sandbox' that is the free market in the banking and lending arena. Consequently, this has allowed the banks to come up with some unique - if predatory - lending practices that are simply bad investment thinking.

I don't think you simply hand Wall Street bankers a bag of money either. Any bailout has to be accompanied with a few strings:

1. Accountability. Not just to the shareholders, but to the public. Sorry Mr. Banker, but you've proven that you are not mature enough to run about unsupervised.

2. Regulation. A process must be put in place that will lead to a balanced, regulated marketplace.

The "free market" is a concept, but it works fundamentally by being "just slightly" out of balance - rather like standing on a wobble board. Ideally it is always counterbalancing itself. Regulation does not exist to prevent the market from changing and adapting, but rather to identify when the situation is becoming unbalanced to to prevent it from doing so.

If you will, it should be the equivalent of speed limits on the highway - intended to keep things more or less in check, but recognizing that you cannot catch all of the cases where things go a little too nutty.

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