Government Regulation to Blame

Government regulation, not free-market greed, caused this crisis

When government distorts incentives, the invisible hand can become a fist. Many observers, including most politicians, have blamed the ongoing financial crisis on the "free-market greed" supposedly unleashed by the "reckless deregulation" of the financial system. Such arguments are rhetorically powerful, but they don't stand up to scrutiny. If they go unchallenged, however, they could hasten a "solution" that's worse than the problem. That's why it's so important to examine the record. What it shows is that government regulations and other interventions – not greed – are the major cause of our current problems...

Firms are profit seekers, but they will seek it where the institutional incentives signal profit is available. In a free market, firms profit by satisfying their customers, investing wisely, and making prudent loans. Regulations, policies, and political rhetoric can change those incentives...

To call the housing and credit crisis a failure of the free market or the product of unregulated greed is to overlook the myriad government regulations, policies, and political pronouncements that have both reduced the freedom of this market and led self-interested actors to produce disastrous consequences, often unintentionally...

Fueling this speculative fire was the Federal Reserve, also a government-sponsored organization. The Fed moved interest rates to extraordinarily low levels beginning in 2001. The additional credit it provided artificially lowered the cost of mortgages and dramatically accelerated the housing boom begun in the 1990s. Did people suddenly get greedy in their pursuit of McMansions, second homes, and flipping homes for easy profit? Yes, but only because abnormally low interest rates made it foolish not to be. This was hardly a failure of free markets or greed. It was the predictable consequence of government distorting the interest rate...

Good intentions are not enough in designing public policy. Regulations designed with the best of intentions are likely to lead to more crises if they distort incentives and thereby cause individual "greed" to undermine economic growth and harm millions. History is full of examples of politicians adopting short-run solutions without seeing the harmful long-run consequences. Today, the calls to "do something" are loud. Yet amid the cacophony, there are a few voices urging not more, but less; not faster, but slower; not short term, but long term; not intent, but outcomes. Those are the voices we should heed, because if we had listened to them 15 or 20 years ago, we might not be where we are today.

Steven Horwitz is a professor of economics at St. Lawrence University.

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