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The Proper Role of Government in the Free Market April 10, 2009

Posted by federalist in Finance, Markets, Regulation.

Socialists have grabbed onto the (largely government-caused) financial market crisis of the last year as evidence that capitalism and free markets are inherently defective.  I believe this has been adequately debunked: government meddling in home finance and labor markets was not only a primary cause of recent crises, but subsequent “bailout” measures have only exacerbated problems that the free markets were equipped to most efficiently resolve.

Early in the crisis I addressed the limited but justifiable role government might play in the markets.  Amar Bhide has a good essay continuing this theme.  In particular he notes the government regulatory institutions that were already in place to deal with market crises:

Our government plays an important ameliorative role. Unemployment benefits stop major dislocations from creating the widespread hunger and homelessness experienced in the Great Depression. They also prevent the anxiety of more than 90% of the workforce that remains employed from turning into a panic.

Bankruptcy laws and courts facilitate the orderly unwinding of obligations that individuals and businesses can no longer meet or easily resolve through bilateral negotiations (as is often the case when a troubled business faces many creditors with different kinds of claims). A bankruptcy code that quickly salvages the greatest possible value from failure is crucial for our economic dynamism.

The Federal Deposit Insurance Corporation (FDIC) immediately assumes the liabilities of failed banks and then gradually disposes of their assets — a process that has ended the bank runs that used to trigger depressions until the 1930s. But beyond amelioration and providing the judicial (or in the case of the FDIC, quasi-judicial) procedures for reorganization, there is little more that the government can do to accelerate the unwinding and renewal necessary to put the economy back on an even keel.


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