More Tinkering

Whenever there is a bust, the knee-jerk reaction is, "The free market screwed up because people are dumb and greedy." What we usually fail to take into account is that the market is NOT entirely free and unhampered, and we rarely review the ways that we are already tinkering with the market.

Thomas Sowell has been writing about zoning restrictions and programs encouraging lending to folks with low-incomes, which is a form of government tinkering.

However, the government tinkers with the market in a much more fundamental way.

I assume you have all heard of the term "bank run". This is what happens when customers lose faith in their bank, and they all try to withraw their funds at the same time. These are moments in history when the man behind the curtain is revealed, and we are shocked to discover that the wizard does not hold the power he claims. The reality is that my money is not really in my bank. Someone else has it. My bank may have lent it to someone to buy a house, or start a business. They hope to get it back eventually, but there is no guarantee. When banks behave irresponsibly, and their investments fail, consumers catch wind of what's happening, they become concerned about their life savings, and they make a run on the bank. Bank runs are the markets punishment for malinvestment. The government does not like bank runs. So, they have gone to great lengths to discourage bank runs and insulate banks from bad investments. Most businesses are allowed to fail when they make bad investments. Banks belong to a privileged protected class.

The result, as always, is predictable. Banks engage in riskier behavior than they otherwise would because they are insulated from consequences. As I mentioned in my last post. You can take GREED for granted as a part of human nature; RISK, however, is a product of environment.

In general, the market punishes the risky banks through bank runs, and rewards the banks that provide real returns for their customers money. The market could encourage conservative investments by making runs on the banks, but the government doesn't like this approach. Alternatively, the government could change regulations (I do believe, after all, in some government regulations; I'm a conservative/libertarian, not an anarchist). Banks could be required, for instance, to keep a higher percentage of cash on hand for non-interest bearing accounts. This would contract the supply of money available and encourage more conservative investments. I think a better approach would be to require the banks to be more transparent. Customers should know what percentage of cash banks have on hand. Customers should know the risks they are taking. Risk-averse customers could put their life-savings into banks that retain higher cash reserves and engage in more conservative investments.

Neither political party is willing to travel this road because Republicans are convinced that a boom can be sustained indefinitely by expanding capital to investers (supply side) and Democrats are convinced that a boom can be sustained by expanding capital to consumers (demand side). Neither are interested in the slow sustainable growth that results from a hard currency and tight (or at least transparent) credit. Unemployment is always too high. Government spending is always too low. The McMansion on the sand is always preferred to the Split-Level on the rock. After all, the floods and the rains don't come every day, so we always seem to have time to rebuild.