The government also needs to think about what regulation will look like in the future. The SEC is antique. It is using pencils and erasers to regulate a 21st Century marketplace. The OTC derivatives market is largely unregulated. It should stay largely unregulated, but the trading in it should be forced to go through a clearing house.
A clearing house will eliminate the counter party risk that Joe assumes when he sells his car. It will allow the trading to happen, but will have a system set up where payments and collections can be made to the correct parties. When the market goes crazy, the clearing house guarantees that things get sorted out appropriately. We avoid the panic of the last year.
It is questionable whether the bailout will do any good whatsoever. Many economics professors across the country have written about their skepticism. It can be argued that the free market capitalism that our forefathers embraced has served us well lately. Goldman was propped up by Warren Buffett. JP Morgan bought Bear Stearns and WAMU. Merrill Lynch was bought by Bank of America. Morgan Stanley converted to a commercial bank, and is certainly shopping for capital since they are still insolvent. Citibank is looking at Wachovia. All these instances are signals that the free market is working. Once something gets cheap enough, there is someone there to pick up the pieces and take a risk on buying it. Sometimes it takes bankruptcy to get there, but the market always wins. Government intervention usually just delays the inevitable.
We need to ask this question: If the government did nothing, what would happen? Certainly, stock market value would go down. People would realize that there will be a credit crunch coming that will affect business, so they will sell. They also may have a lot of their own savings in the equity market, so they will sell to get cash. Cash is less risky than holding stock. Some may draw out cash from their own banks, putting pressure on the banks to borrow from the Federal Reserve. This will drive up interest rates. Higher rates will incent people to keep their cash in the bank, to generate some return-as long as they feel the US banking system is stable. They should, because we have the FDIC. Some companies and banks will go bust. People will get hurt. The market will pick up the pieces, and reform them into new enterprises. It will be painful, and could take some time-no one knows how long.
Even with the bail-out, it still will be painful. Taxpayers will be on the hook for a lot of paper that the market cannot value even today. It may be profitable, but it might not be. If the bailout doesn’t work, we will see futher declines in the stock market and asset value than if we did nothing — so what ever they propose better be bullet-proof. Personally, I don’t have a lot of confidence in the Congress, Treasury, and Federal Reserve to cobble together a cohesive plan that covers all the bases.
With elections on the line, there is too much temptation to play politics and not do what is right for the market.
But still — perhaps the right thing to do would have been to listen to the lessons of Adam Smith and Milton Friedman and let the capitalistic market work.