Free Markets ended in 1912

Businessworld
Robert F Bruner
(The author is Dean, Darden Graduate Business School, University of Virginia)


The immense rescue legislation passed by the US Congress marks a historic watershed for the world. Critics from both ends of the political spectrum proclaim the passing of free-market capitalism. If you think the world has had a free-market financial system, think again. A free market avoids the distortions due to regulation; buyers and sellers drive the outcomes; competition is rigorous, and can produce volatile results; there is free entry and exit; investors are free to take risks, harvest any gains and bear any losses.

The free market in finance in the US ended in 1912 with the legislation to create the Federal Reserve System, the central bank. ‘Free market’ does not describe well the financial services industry in the world today: government agencies regulate the entry, exit, and combination of financial institutions; they oversee the transparency of financial reporting and securities underwriting; they influence credit and capital policies of lenders; they manage the money supply through which they drive interest rates and inflation expectations; and they provide the electronic system through which vast quantities of cash are transferred.

Government-sponsored entities such as Fannie Mae and Freddie Mac fuelled the extraordinary expansion of mortgage lending. Since 1978, the US government has managed financial markets to maintain full employment and stimulate economic growth. Similar practices prevail in many other countries.

Government coffers are easy targets for special interest groups seeking to save certain firms, jobs and industries. With the bailout of the US banks, you can be sure the auto and air transport industries will be close behind seeking a safety net. Risk-reduction afforded by regulation is not costless. Do we want an absolutely risk-free society? Absolute risk reduction would choke off innovation, entrepreneurship and growth.

The current crisis is distinguished from previous crises by very great complexity, high speed of news and cash, and very large scale. It is hard to imagine the wreckage that would have occurred by now without the government’s interventions to date. The regulatory innovations roiling the markets do not strike me as the death knell of comparatively free-market capitalism. Or at least, if there is a death to grieve, then it must have happened a long time ago.