An Engineer

In economics 101 you learn that when you interfere with market forces, you disturb the delicate balance of the market. Rent price control creates shortages and diminishes the incentives to renovation apartments; the careful control of the number of medallion taxes and the prices they can charge creates imbalances where there are sometimes a slew of taxis and other times insufficient numbers.

It is not hard to reason that our creation of Freddie Mac and Fannie Mae, with their implied government guarantees, created an incentive to originate loans that were more risky than what the market would normally tolerate. The result was an increase in asset prices (more money chasing real estate) and an eventual collapse.

In a sense, we got what we designed. Our goal was lofty enough: to enable widespread home ownership. Nobody can argue with the social goal. But the price to pay is exactly what is happening here.

Our solution is to bail out all parties involved. The risk is that we are once again changing the incentive structures to the market-based system. If I know that I when I win I win and when I lose, I win, then I play a different game. We got the current disaster when the investment banks did not know that the federal government would bail them out. Imagine how they would play the game if the knew it was impossible to lose.

Only in cases where the social consequences are clearly undesirable should we impose regulation. Labor working conditions, environmental laws, are areas were regulation is desirable. But even there, it is better to use a market based approach. For example, polluting the environment has a societal cost and to do it, you should pay a high price that reflects your overall consumption of global resources. A market for carbon credits can work.

In addition, I like to pay along the way for my regulation versus all at once. While a minimum wage law certainly has economic consequences, but we can see them along the way. The implied guarantee of a the federal government on trillions of dollars of mortgage assets is exactly the type of ticking time bomb that creates increased volatility and occasional castotrophic collapses.

I agree that we should think very carefully before we use taxpayer money to bail out private companies from their bad decisions.