Thoughts, essays, and writings on Liberty. Written by the heirs of Patrick Henry.

February 19, 2009

Resolved: The Economic Downturn Is Not A Market Failure

by Doug Mataconis

Matthew Parris has an interesting argument in The Spectator that is worth quoting at length:

[A]mid all the doom-mongering and recanting, I have an assertion to make. The market has not failed. The present collapse is evidence that the market is working. Confidence bubbles are an inherent feature of a free market system. Panics — confidence vacuums — are an inherent feature too. The test of the theory of market capitalism is whether the system provides from within itself the means to prick both.

It does. The first — a confidence bubble — has been pricked. We are now sucking ourselves the other way: into a confidence vacuum. In time this too will be pricked. The market will steady.

The bubble that has just burst was based, worldwide, on financial services. Financial services are a product. It is true they are a product critical to the efficient functioning of the market (so is electricity, so is oil) but that just makes them an unusually important product. From time to time products fail in any market. They may fail through force majeure — droughts, floods, pestilence. They may fail due to inherent flaws — airships, Thalidomide, blue asbestos. Or they may fail through ignorance, trickery or the credulity of human beings — Madoff, the property bubble, the repackaging of sub-prime debt.

The present financial crash has been precipitated by product failure of the third kind. Trade in financial instruments too opaque for even those who traded in them to assess them properly, and bonus incentive schemes that acted against the interests of the companies offering them, fuelled a banking bubble that has now burst.

But ask: what pricked it? Did politicians rumble the trade? Did governments, or international forums or symposiums, provide the sharp instrument? Did academic research and expertise expose the dodgy product? Did statutory regulators apply the pin? No, the free market wised up and pricked this bubble. Politicians and finance ministers (if they had had the power) would have tried to keep it inflated. The market puffed itself up, and then, without intervention — despite intervention — the market let itself down. The speed with which this has happened has been awful, but however inconvenient for many or catastrophic for a few, correction is not a failure of the market, but a success.

The Austrians among us would go further and argue that the bubble was itself created by the distortions in the market that are the inevitable result of government fiscal and monetary policy or, in the case of the various regulations that made it easier for people to buy houses they couldn’t afford, government social policy. The market, they would argue, did they best that it could to absorb these distortions but, over time, it was inevitable that the distortions — the “bubble” as some might call it — would become far too big to sustain itself.

And so, the bubble pops.

Parris is also correct when he notes that not only didn’t politicians have no role in popping the financial bubble, they did everything they could to sustain it and, even today, are implementing policies that are ultimately aimed at re-inflating the housing bubble that started this disaster.

For many reasons, blaming the current crisis on free-market capitalism is absurd, not the least of them being the fact that we have no such system in existence anywhere in the world at this time.

What nobody seems to consider, though, is the possibility that the crisis we’re living through today is itself a sign that, in the end, the free market works.

H/T: Hit & Run

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  • http://pith-n-vinegar.blogspot.com/ Quincy

    This is one of the reasons my teeth gnash every time some politician or MSM talking head uses the term “home value” in place of the correct “home price”. Home values, the amount your home is worth relative to those in your market, have been extremely stable. Home prices have fluctuated wildly as the bubble grew, popped, and burst.

    As this happened, home prices came back into line with price and wage levels elsewhere in the economy, and housing started to become affordable again. But, the politicians think it’s better to keep irresponsible people in their homes and keep the bubble going than to make home ownership available to responsible people in the next generation by letting the market work.

    Yet another act of intergenerational economic warfare from Washington D.C.!

  • http://www.belowthebeltway.com Doug Mataconis

    Quincy,

    This is one of the reasons my teeth gnash every time some politician or MSM talking head uses the term “home value” in place of the correct “home price”. Home values, the amount your home is worth relative to those in your market, have been extremely stable. Home prices have fluctuated wildly as the bubble grew, popped, and burst.

    It’s also why my wife won’t let me watch that HGTV show “My House Is Worth What ?”

    The numbers they come up with are as phony as a three dollar bill and yet the realtors are presented as “experts” and the homeowners are actually happy when they get a high number.

    By the end of the half hour, I am usually yelling at the television ;)

  • Matt Spong

    Couldn’t have put it better myself. You are exactly correct.

  • http://pith-n-vinegar.blogspot.com/ Quincy

    Doug, don’t you know that HGTV is just a propaganda outlet for the decorating-industrial complex Eisenhower kept warning us about?

  • http://www.persnicketycurmudgeon.com persnickety curmudgeon

    Quincy – I fear you’ve fallen prey to the propaganda of Century 21 – we do not own HOMES we own HOUSES.

    Oh and if anyone really cares about fixing this mess quickly – contract supply! Start tearing some of these houses down!!

    As house price/values – yuck! IF only 10% of the populace can afford say a $400,000 house, no more than 10% of houses should be valued at $400,000.

    We are using NASDAQ style pricing for the housing market and it’s BS.

    A COMP is a tool for guiding one in how many pounds of flesh they might tru to seperate from a potential buyer NOT what one’s house is “worth” as collateral to some addled loan office willing to risk a $50,000 equity loan default in exchange for a quick $500 closing fee.

  • http://pith-n-vinegar.blogspot.com/ Quincy

    persnickety –

    You’re right, it’s houses, not homes. That only makes the term “home values” doubly bad.

  • http://pith-n-vinegar.blogspot.com/ Quincy

    Oh, and about fixing the mess, it depends on whom you’re trying to fix it for.

    For responsible people living in homes they intend to keep and can afford, there’s no mess. The group they’re trying to fix the mess for is the irresponsible people who took on more loan than they should have and those who might have bought high and would have to sell at a loss.

    The problem is that the bubble created a whole different mess. It locked responsible people, mainly young buyers, out of the housing market by artificially driving prices up. If you fix the mess of declining prices for the irresponsible, you exacerbate the pain for the responsible.

    Here’s my simple plan: For one year, offer any homeowner who is in risk of default on their primary residence the opportunity to have the government pay the difference between the sale price of the house and the loan amount, if the loan exceeds the sale price. For example, a person who is about to default on a $650,000 loan on a house with $400,000 can sell the property and have the pay the bank the difference.

    The borrower has the chance to get out of the loan before foreclosure occurs while the bank has a chance to recoup the full value of the loan, significantly shoring up balance sheets without massive bailouts. It gives the federal government a chance to lessen the damage caused by the Greenspan doctrine of using a loose money supply to forestall the business cycle. Finally, and most importantly, it allows market forces to work in finding the true price level for current economic conditions.

  • http://www.persnicketycurmudgeon.com Persnickety Curmudgeon

    …about fixing the mess…

    This is about the best idea I’ve yet heard on how to get out of this mess with the least ongoing cost!

    By the way – did anyone else see Rick Santelli’s rant on CNBC yestereday?

  • TerryP

    Quincy

    I don’t see how rewarding the banks who made these loans and the people who made poor decsions in taking on these loans with money from responsible taxpayers does anything to solve this problem. The homeowner and the lender need to bear some if not nearly all of the pain. Making the bank whole does not make them bear any of the pain. While the homeowner bears the pain of having to move out of the house, financially they are not bearing any of the pain.

    Quite simply if the normal process is allowed to occur, the same thing would happen except the people who made the poor decisions would be the ones bearing the pain. The banks would be taking the hit financially and the homeowner would have taken a hit on his credit history, be out of the house, and lose any equity that he may have had at one time. The person that is not hurt is the responsible taxpayer, as it should be. The gov’t just needs to get out of the way and let this occur as quickly as possible.

    If the gov’t does need to help it should concentrate on helping people who have lost a job with unemployment compensation and job training. Otherwise just get out of the way so this mess can be handled as swiftly as possible by the market. The gov’t should look at ways to decrease it’s spending so in turn the taxpayer can keep more of their own money to spend/invest on their priorities.

  • http://pith-n-vinegar.blogspot.com/ Quincy

    Terry –

    I don’t see how rewarding the banks who made these loans and the people who made poor decsions in taking on these loans with money from responsible taxpayers does anything to solve this problem. The homeowner and the lender need to bear some if not nearly all of the pain.

    It’s not about rewarding banks, it’s about ameliorating one and only one symptom of the housing bubble–the irrationality caused by the government. The FedGov has a lot of responsibility to bear in the credit and housing bubbles, and quite frankly it has to address the price whiplashes it has inflicted on people through it’s mistakes.

    I’m offering a plan that allows banks and borrowers to be relieved of pain *only* in situations where it’s caused by the FedGov’s mistakes, and only on primary residences.

    The tremendous and unprecedented correction in housing prices currently underway is creating a class off toxic assets on bank balance sheets that could not have been forseen by anyone. I look down the street here and see a house that would’ve sold for $1,000,000 just 18 months ago now selling for $400,000. Someone who bought at the peak of the bubble has a really big incentive to say **** it and walk away from the loan, making these loans toxic on bank balance sheets where they normally wouldn’t be.

    My plan seeks to address this in a way that lets the housing market find the true clearing price. The borrower isn’t keeping the house, and the bank isn’t keeping the loan. Each time a transaction occurs under my plan, a home has been purchased at market price. This is big difference from the Obama plan, which specifically seeks to prevent the housing market from finding equilibrium.

    Face it, Terry, taxpayer money will be spent to try and stabilize the housing situation in this country. If the instability had been caused simply by private citizens and corporations making mistakes, I’d be right with you in saying let them bear the pain. Mistakes were made by the FedGov, and the FedGov bears the responsibility to clean up its part of the mess for the lowest cost possible. My plan does exactly this.

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