Market Failures

Was there a market failure in today's crisis? I don't know. Some say yes. Some whom I really respect say yes. Some whom I don't respect also say yes. I don't know. I'm skeptical but I also realize that I'm ignorant.

But let's say that private financial markets did contribute to this. And the contribution was completely independent of government intervention.

Ok. So what? Markets produce failure all the time. A company that opens up it's doors with a poor business plan is going to fail. It should fail. That failure is not the fault of the government, nor is it the fault of lack of regulation. It's the fault of the company having a bad business plan. What happens in the market is that the company with the bad business plan is quickly discovered and put out of business. Such a company could not serve it's customers nearly as well as the alternatives that the customers had. Such non-serving companies should fail. And the market discovers these things very quickly.

So this makes me wonder if the failure in the financial markets is just another normal, run-of-the-mill failure. If it is, then that failure should be allowed to proceed so that the bad (non-serving) ideas that were created go away.

What then is the purpose of the bailout package? It recapitalizes financial institutions that were in trouble. In other words, it bails out the bad ideas and lets them live a bit longer. Is this good? It's hard to think that it is. It's more likely that bad ideas that aren't allowed to die will create more destruction in the future.

So, I find it ironic that it is our politicians who are claiming these two things at the same time:

1. The financial market failed.
2. Let's bail out the financial market.
   

Either the financial market has bad ideas that should be allowed to die or it has good ideas that should be bailed out. These two statements seem inconsistent.

But I realize that they seem inconsistent to me because I'm focused on the ideas behind the financial markets. Are they good or bad? But these statements might not be focused on that question. Instead, they seem to be saying that the problems we're seeing today would not have happened if the government were running things. So, let's not trust the market, rebuild the failed banks and then have them run by the government. And we'll be good.

Of course for this to work, it requires that we ignore the fact that the government is not immune to failure. And we must also ignore the reality that government failures are *MUCH* harder to undo than market failures. Bad laws, even ones that everyone agrees are bad laws, live on. We have to ignore those inconvenient facts. We seem to be blissfully willing to do that.