Panglossian Government

By Chidem Kurdas

Richard Posner’s new book, A Failure of Capitalism: The Crisis of ’08 and the Descent into Depression, probably reflects the conventional wisdom of the day. By this view, the twin credit and real estate bubbles and resulting collapse happened mainly because banks were deregulated. The solution is a more active government to restrain and supervise financial institutions.

Theoretical welfare economics set real markets against an idealized government, James Buchanan pointed out. Markets were rife with imperfections; collective action would apply perfectly calibrated corrections. But then public choice economics looked at the workings of the real thing, “politics without romance,” as Mr. Buchanan put it. Now the old double standard has re-emerged in nostrums offered for the financial industry.

Asked who’s to blame for the crisis, Mr. Posner told a journalist: “Primarily the deregulation movement—people like me who didn’t carve out banking from the other industries to be deregulated.” Banks are too centrally important to be deregulated, according to the chastened deregulating judge and prolific author.

Robert Solow, in a review of Posner’s book, largely agrees, though he makes the point that the current economic malaise should properly be called a serious recession rather than a depression as Posner styles it. Panglossian ideas about “free markets” encouraged lax or no regulation of a potentially unstable financial apparatus, Mr. Solow says.

One can find numerous examples to counter the notion of regulation as cure-all, but the folksy-sounding Fannie Mae and Freddie Mac are probably the most dramatic instances. The Federal National Mortgage Association and Federal Home Mortgage Corporation, to give their full names, were set up by the government to purchase and securitize mortgages. They sit at the very center of the economic crisis.

They own or guarantee trillions of dollars of mortgages.  When they became insolvent last year, they were taken over by the government, as had been expected all along. The US Treasury committed a total of $400 billion to bail out Fannie and Freddie, while sparing them the stress tests other financial institutions underwent.

Powerful politicians like  Barney Frank have long protected the mortgage giants, even after their accounting scandals in the early 2000s made Enron look like a babe in diapers.  The government does not keep its own financial house clean. In fact it has spawned a uniquely corrupt political-financial mortgage complex. Why the presumption that the same government can keep other financial institutions out of trouble?

You could argue that Fannie and Freddie are special cases. As part of a big political agenda, they are treated differently. “I think we see entities that are fundamentally sound financially and withstand some of the disaster scenarios,” Mr. Frank said in 2003 about the mortgage giants. At another hearing that year, he said: “I want to roll the dice a little bit more in this situation towards subsidized housing.”

No question, politics came to play big time. But why wouldn’t politics come to play with other financial businesses? There are interest groups that stand to gain or lose in all financial decisions. There will always be politicians who want the roll the dice towards a certain direction.

2 thoughts on “Panglossian Government

  1. Nirvana Fallacy–I really like that term. There should be signs everywhere regulation is discussed, saying “Beware of Nirvana Fallacy.”

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