The distortion of free markets

by dpollak on December 1, 2009

miracle cartoon The distortion of free marketsYou can hardly turn on the news or open a newspaper without hearing or seeing headlines about another government program to rectify the ills of the economy. I have to admit that as a somewhat conservative leaning person, I have found some comfort in government programs that are directed towards economic recovery. Lately, however, I’ve become increasingly uneasy about what it all means for the future.

Last weekend I spent some time with a friend of mine that is a bankruptcy attorney. I asked him if his business was “off the charts strong”. Surprisingly he said that it wasn’t. He explained that although there are more people than ever who are upside down on their mortgages and various loan payments, relatively few were prepared to file for bankruptcy. The reason is that the government is providing so much assistance and encouragement for lenders to reform and forgive debt that people don’t want to file for bankruptcy. He explained that this is a perfectly understandable response as bankruptcy is often seen as a solution of last resort and one that carries a negative social stigma. After all, why would anyone file for bankruptcy when there is a hope that all or a significant part of their loans might be forgiven.

My bankruptcy friend Bob further explained that this all too common response creates several disturbing concerns. First, it reinforces the notion that people can over extend themselves without having to face the consequence of certain repayment. Bob cited numerous instances where people that would otherwise face bankruptcy continue to spend and borrow with the belief that it will all be forgiven. Without an unpleasant backstop of bankruptcy, there is no incentive for fiscal responsibility.

Bob also cited frustration in not knowing how to staff his office in the coming year. Bankruptcy work requires a great deal of administrative effort associated with completing and filing forms, checking on statuses and similar procedural work. Government programs, unlike the free market, distort the market and make it extremely difficult for business people like Bob to plan and deploy resources. For example, it’s unclear whether he should lay off people that would otherwise be needed if not for the government programs, or whether he should hire staff in anticipation of present programs expiring. There is simply no rational way to allocate resources when the government is in charge of decisions that would otherwise be left to the free market.

I think that all of us in the automobile business got a dose of this lesson with Cash for Clunkers. This government program stimulated both new and used car sales in the fall. Many were left wondering to what extent they should replenish inventories. Would demand revert to pre-incentive levels, or would it create a hang-over effect? Will there be another government stimulus plan for automobiles in 2010? If so, when, how much and for how long? Although I don’t think another program is likely, you can begin to see the uncertain effect that government intervention has on businesses that are affected by such programs.

As one that believes whole heartedly in the power of the rational market, albeit with some reasonable levels of regulation, I think that we must all recognize the dangerous consequence of continued government market intervention. After all, we all know the disastrous consequences of central Soviet planning as well as the stifling effects of European style socialism. As our economy shows signs of recovery, it is now time for us to call for reasonable expiration of undue government intervention.

 

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Tagged as: Bankruptcy, Bankruptcy Law, Business, Debt, Economy, Law, Lawyers and Law Firms, Services

  • Ruggles
    Of course the most vibrant economy in the world these days is China, but mostly because of how that country had been repressed for so long. There is no way to predict how their central planning will work as their economy matures. There is no doubt that "regime uncertainty" causes investors to "get up on the fence" while the wait to see how things shake out. As our government tries this, that, and the other, it has a paralyzing effect on business and investment. This coupled with a lack of consumer confidence means we are in for a long hard road ahead.

    I lived through the Reagan era as a Chrysler dealer. Reagan didn't have a magic wand either and unemployment and weak consumer confidence lingered well into his first term. It looked like he wouldn't be elected to a second term, but getting shot boosted his approval rating. The economy had improved enough by the presidential election that he won in a landslide.

    In my view, we had been lulled into a sense of false security during the housing boom. We all thought that moves taken after the Great Depression would prevent us from falling into the abyss. The repeal of Glass Steagall didn't seem like a big deal, but it was. We had weathered oil crises, the S&L meltdown, the junk bond collapse, the tech bubble bursting, etc. But when Lehman Brothers was allowed to go down and 780 billion dollars was ELECTRONICALLY extracted from the money market system, the term "run on the banks" took on new meaning. I had not been aware of this but during the banking crisis of 1930 following the 1929 collapse of the stock market, 28 states were left without one open bank.
    Hence, we ended up with a hurriedly constructed TARP, which for all it's faults probably saved us from the abyss.

    There are sins of commission and sins of omission and the government is capable of both. The idea that insurance products like Collateralized Debt obligations and Credit Default Swaps should be allowed to be sold without oversight or regulation, with NO RESERVES required to pay claims is the most egregious dereliction of duty on the part of government I can recall in my lifetime. These guys sold these "policies" which prompted Fitch, Moddy, etc. to rate the "insured" investments as AAA, thereby transforming drech into gold. And the world gobbled them up. When it hit the fan, it was us as taxpayers who had taken the risk while AIG, Goldman etc. pocketed the spoils. When the ABS market collapsed, so went 40% of our credit system.

    Stuff like this is enough to turn a good lifetime Republican into a Democrat! I'm ready to live with additional regulations. But I'll sure be happy when things are settled enough for people to make business decisions.
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