The Free Market’s Not Dead

Critics from both ends of the political spectrum proclaimed the passing of free-market capitalism. On the right, conservatives mourn the historic intrusion of government into private markets. And on the left, pundits rejoice in the end of the Reagan era and the triumph of socialism. The critics are only half right: While this is an important moment, they are wrong about its meaning.

If you think the world has had a free-market financial system, you should think again. In a free market, distortions due to regulation are avoided; buyers and sellers drive the outcomes; competition is rigorous and can produce volatile results; there is free entry and exit; investors are allowed to take risks, harvest all gains and bear any losses.

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“Free market” does not accurately describe 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 fueled the extraordinary expansion of mortgage lending. Since 1978, the U.S. government has managed financial markets to maintain full employment and stimulate economic growth. Similar practices prevail in many other countries.

And then there are the supra-national institutions, such as the IMF, World Bank and Bank for International Settlements, which aim to promote financial stability on a global scale. With this much government intervention, it is hard to label governing philosophy of the financial services industry as “free-market capitalism.” Eventually, there will be a reckoning: How did the government contribute to this crisis?

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