Deregulation, slayer of the free market

The theory is that free markets work to create efficiency as a result of competition. There is a need to produce the best product at the lowest cost because other companies will be doing the same. Some economists posit that regulation of industries harms the markets by limiting the activities a company can undertake to lower prices, creating inefficiencies in the market.

The Consumerist touched on the biggest problem with this theory. It encourages extremely risky decisions. Though we have removed many regulations on various industries, and in particular the finance industry, the government is still imposing itself in the market in one key way. We are still bailing out companies who make unfortunate decisions.

The problem? The ever-present bailout guarantee. Banks’ money comes from depositors (us). Deposits are insured by the FDIC so that if the banks lose our money, we get it back. We are insured. So we don’t care if the banks lose our money or not, which means nobody is really pressuring the banks to behave.And why would they, since they can expect a bailout from the government. If they fail, they take the economy with them? But the only entity that is not insured—the government, including its own depositors, the taxpayers—gave up by deregulating. (Okay, not completely, but let’s be honest, the government is regulating the banking industry about as much as I regulate my cats.)

Posner says he thinks the big banks knew exactly what they were doing: that it was risky, but that they could get away with it because they “are . . . considered by federal regulators too large to be permitted to go broke.”

In the case of individuals, we often hear grousing about how the poor ought to pull themselves up by their bootstraps and such, when it comes to large companies, we are quick to bail them out lest their misfortune becomes ours.

It would be one thing, in a country where we carefully regulated industries to mitigate our exposure to risk, to bail out companies in times of crisis. There are critical industries, for instance the transportation industry, that simply aren’t affordable without government aid.

To expect this money to flow freely without any expectation that care will be taken to prevent recklessness, is simply insane. Ask any insurance company if they’ll insure your house knowing you have faulty wiring. Ask them if they’ll insure your car if it won’t pass an inspection. Then ask yourself if it’s any different to expect a bailout without an assurance that it won’t be used as insurance against carelessness on the part of corporate America.