Joseph Lee's Perspectives
My view of the world
October 9, 2008 - The Free Market Solution to the Financial Crisis

                As a graduate of the University of Chicago and an avid fan of Merton Miller, I support smaller government and oppose the idea of government imposed solutions.  However, there are at least two fundamental fallacies in the argument that a so-called free market solution is the way to go for the current financial crisis.

                First, free market capitalists need to come to the realization that there is no such thing as a perfectly free market.   There simply are too many situations where the invisible hand could not handle the problem.  When 9-11 occurred, we all agreed that it was wise to use government forces to deal with the issue in Afghanistan.  Whether you agree with the Iraq policy or not, no one will suggest that we send private armies into combat and let a free market solution solve the military problem.  In essence, society agrees that the role of defending the nation (and to attack others) needs to be done by government, not because it is the most efficient way, but because it is not solely a financial problem.  Yet, one can argue persuasively that the war in Iraq is a significant cause of the current economic crisis.

                Likewise, when Hurrican Katrina hit, and more recently with Hurricane Ike, the recovery effort requires the hand of massive government intervention.   This has less to do with who is better in handling such recovery efforts but more to do with societies call that government help its citizens in times of crisis.  I recall one of my accounting professors in Chicago tell me that it less about capitalism and free markets, but more about how big of a circle we create to make certain decisions.   The choice to buy a red shirt or red-tie could be made by an individual, but the choice to build a neighborhood road will need to be done at the city level, and the choice to build national superhighways can only be done at a national level.   Implicitly, we understand that government has a role, and that the role is not static, but rather a dynamic one.  And that is why we vote for mayors, governors, Congressmen, and Presidents.

                The current financial mess became a socio-economic crisis with a succession of bank failures and warnings of dire consequences by some of the most respected figures in the nation.    We are witnessing panic selling on Wall Street and the Asian Markets even as I write this.  The argument that the solution should be based on free market or capitalism makes a fundamentally flawed assumption that the banking institutions and capital markets were free to begin with.  Bankruptcy laws are just that—laws written by Congress.  That’s government intervention.  That the banks have capital reserve requirements is dictated by regulations—once again, another series of laws.  That’s government in action.  I don’t hear many free market capitalists calling for abolishing capital requirements for banks.

                The turmoil in the markets will one day settle down.  Few would be able to say for certain whether the $800 billion bailout (EESA = Emergency Economic Stabilization Act) worked or didn’t work.   In the end, it will be the masses—the people—who will make that decision.  Someone will decide by walking up to an auto dealership and buying that new car that is selling at such a great discount.  The banker who believes that the worst is over will then make an auto loan to that person.  The automakers will then decide that with the lower oil prices, US drivers may drive more.   Investors might then think that there are bargains available for them to pick up in the stock market.  If enough people believe it's working, it'll work.

                The people will not open their ECON 101 text books to study if they regained their confidence because the solution was based on free market or government intervention.  They may be pissed off at Wall Street executives who weren’t thrown in jail, but if their jobs are good, and the future looks bright, they will learn to look the other way. 

                And they will also be glad that their government didn’t over-react by nationalizing all the banks, imposing arbitrary ceilings on executive compensation, or by issuing mandatory price and wage freeze orders.  They will also be thankful that the government decided not to throw money at infrastructure projects just to create jobs for more Bridges to Nowhere.

                As crazy as the world may seem, our markets are still relatively free, the government is still working (as bad as it was before), we don’t have rioting in the streets, and the lawyers and accountants are still making money.

                Just take a look a the EESA.  There are plenty of jobs for asset managers, accountants, lawyers, and guess who—bankers.  The free market just keeps getting freer.


Joseph Lee is formerly a partner with KPMG LLP, and currently teaches at both the Peter F. Drucker & Masatoshi Ito  Graduate School of Management in Claremont and Pepperdine's Graziadio School of Business and Management as an Adjunct Professor.


He writes about current business, economic, and totally irrelevant topics from time to time and acts as executive communication consultant for a variety of global firms.

2008-10-10 05:22:17 GMT
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