Libertarianism is dead . . . vive le libertarianism!

Must one pile on Jacob Weisberg?  Why yes, one must.

Not because he is wrong that this crisis raises serious problems with market structure.  It does.  It also raises serious problems with regulatory structures.  It raises serious problems with everything we were doing.

I am not trying to sound like those dogmatic libertarians who declare, any time problems are detected in the markets, that they merely exist because we do not have "true" capitalism.  Sometimes this is true--the interstate trucking market has been indisputably improved by deregulation.  And sometimes it isn't; the market for banking services has been (to my mind) indisputably improved by the FDIC.  Markets are complicated things that rest on a mixture of law, custom, and individual action.  There is no libertarian state of nature in which human beings survived without some form of coercively enforced rules.  All libertarianism can do is maximize the scope for individual action within that framework.

To put it another way, society has multiple possible equilibria, and some of those equilibria are better than others. Removing the existing set of rules does not, of itself, guarantee or even make it particularly likely that we will arrive at a better one.

But that, of course, also holds true of government action.  Punishing the bankers, restraining them from taking certain sort of risks, or giving regulators vastly more power over them, does not in itself guarantee that we will get a better outcome.  I see many people who do not know very much about finance demanding that we reverse the much-vaunted deregulation of the 1990s.  I see very few of them proposing a coherent regulatory framework that will get us to that happy state, much less a political process that will achieve this desireable regulation rather than something else which better suits the legislators.

Nor is there any particular proposal for preventing that institution from falling prey to the same forces that grip the regulated industry.  I have said it before, but it is worth repeating:  the regulators became overconfident in the same way, and for the same reasons, that the bankers became overconfident.  Just as a long and unusually rosy period in the housing market convinced the bankers that they had gotten better at pricing credit risk, a long period without a large bank failure persuaded the regulators that they had gotten better at regulation.  They believed that their computer models, and an improved understanding of how markets and the economy worked, would allow them to see problems in time and halt them.  Obviously, they were wrong.

Now, obviously, you can tell the institution "Don't get overconfident!  Be extremely risk averse!" But for the next ten years or so, this is superfluous; the bankers themselves have learned to be extremely risk averse, a lesson that they will, at least for a while, employ in building their portfolios.  And longer than that, you cannot commit any political institution to a particular stance.  For one thing, extreme risk aversion has its own costs, and the fact that we currently wish we had been more risk averse does not mean that ultra-cautious regulatory policy is actually optimal, any more than it would be a good idea to act, permanently, on your wish that you hadn't left the house and walked into the path of that car.

Moreover, it is meaningless, in a mixed economy like ours, to attribute a massive failure like this to either "the market" or "government regulation".  The people who think that this can all be traced back to the CRA are wrong.  But so are the people who think that the only problem was too little regulation.  Just as some actions by private firms unquestionably put the economy at risk, so did some regulations.  It is indisputable that mark-to-market accounting caused potentially solvent firms to suffer ratings downgrades.  It is also not disputable that a slew of rules surrounding the credit quality of the securities that pension funds and insurance companies can invest in helped trigger the horrific cascading liquidity crises that, as much as anything, forced the government to step in and bail out the banks.  If these institutions had not been forced to keep their assets concentrated in "investment grade" securities, they would not all have had to run for the door at once as soon as there was a ratings downgrade.  Those downgrades, of course, hit the balance sheets of other institutions, some of which found themselves next in line to be trampled by the stampede.  Those regulations were good at protecting against individual firm failure.  But when there was a systemic problem, they made things worse, not better.

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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