Tuesday, October 11, 2011
Free Markets & Traffic Lights
There is a lot of talk about free markets in our economic debates, but free markets doesn't mean that individual or institutional investors should be losers.
Not far from where I live is an intersection called Knowlton's Corner. The main road that leads downhill into Knowlton's Corner is a heavily trafficked 4 lane road called the Ludlow Viaduct. The Ludlow Viaduct brings a heavy stream of traffic down to this intersection where it is one of six roads that converge to form Knowlton's Corner. No traffic engineer or motorist would suggest that this intersection with 6 roads coming together from 6 different directions could function without traffic lights. Common sense would dictate that with 6 roads crossing a common space that some formal apparatus is necessary to help move the traffic without causing accidents and the possible loss of life.
Free markets need "traffic lights" too. Without rules there would be no markets because individual and institutional investors would not feel safe. The recent financial crisis demonstrates for me that free markets need regulations. For many years, the markets operated within a framework of regulations and people on both sides made money. When one side games the system, the resulting fallout not only destroys the trust of the investing public, but it also causes real economic dislocations that will take years to work out. The mortgage-bond meltdown has wrecked the housing market and has caused foreclosures and a decline in the housing market. This is the direct result of the housing bubble created by the fraudulent issuance of triple-A mortgage-backed bonds that in no way deserved the highest credit rating that was awarded to them by the three credit rating agencies.
Everyone wants the other guy to work hard for his money. Why would we want any less from those operating the capital markets?