On the Market

A friend told me that the internet punditry was telling him that "deregulation" was to blame for some of the recent stock crashes and financial institutional tankings. He asked for my free-market alternative explanation.

Problem is, I agree. But not in the way that much of the punditry would like. Regulation's a tricky thing. When you put regulation down, you place an arbitrary restriction on a system, and the system adjusts to compensate. Think about putting a rock down in a river--it flows around. That's problem one--changing regulation forces changes in the economy. But the second problem is weirder--often, regulation causes perverse incentives or weird economic effects, and more regulation is slapped down on these perverse incentives/ weird economic effects to try to prevent them from happening. A good example is in rent control. Large cities have huge swaths of zoning/safety/health/fire regulation--as well as large property taxes on landowners--for residential buildings in the city. With all these regulations and taxes, the landowner incurs a higher cost, and thus raises the rent. With these increases in rent, poor people can't afford rent, and become homeless. Many city governments deal with this by using rent control--they force rent to go only so high. In most models, they control middle-class or upper-class rent; but wherever they control the rent, it causes some apartments to no longer make money, and thus not rent out. Sometimes, the costs are just higher than the government-approved rent. These apartments won't be used, which reduces the supply of apartments. Without an independent change in demand, prices everywhere go up--the poor get hurt hardest. So then the government started subsidizing the rent for these guys... it keeps going. Anyway.

When you have this massive, complex structure of regulation on a system, suddenly stripping some away is clearly going to create problems. The first problem is that an economy does not change as seamlessly as a river--when you yank the rock back out, the system has to adjust, and sometimes that adjustment is violent. But the other side is that if you yank out some of this regulation, th problems caused by other regulations become manifest, in ways that are extremely complex and difficult to predict. I'm not even going to pretend to know exactly what regulated-market problems caused the recent tank--I've heard a lot of jabber on it, and none of it has made sense.

But if this is an adjustment, then a bailout won't help in the long-term--the new equilibrium is one with fewer financial institutions, fewer investment banks, more modest loaning and investment policy. Bailouts to get these guys back on their feet won't magically create a new equilibrium--it's just a use of tons of energy to force them away from the equilibrium.