No Deregulation or Free Market in Banking

My nephew, a high-school senior taking economics, in which his class is now watching Inside Job (which I have not seen), wrote to ask me if there is any “correlation between major economic advisors within the market of the world today and an advocacy of deregulation within their classrooms?” He seems concerned that both private- and public-sector officials who used their authority to influence financial markets then moved to academic jobs where they advocate free markets. The implication seems to be that these big players benefitted personally from the deregulated free market in banking, and now as academics they are justifying the lack of regulation that helped enrich them in what was a fiasco for most people.

What follows is my reply:

Charlie, it’s wonderful to hear from you with a question about political economy. I don’t know how good an answer I can give you without knowing some specifics, but let me try to answer, in a kind of scatter-shot way, what I think you are asking.

First, banking is one of the most heavily regulated industries in the country, despite what one hears about deregulation.

Second, many of the big financial companies, including JP Morgan Chase and Goldman Sachs, were among the biggest beneficiaries of government intervention during the financial crisis. Specifically, JP Morgan Chase was allowed (urged, really) to take over the collapsed Bear Stearns’s better assets, while the Federal Reserve took on $30 billion worth of their shaky assets. Ultimately that means that everyday taxpayers like you and me were put at risk of the likely losses on that $30 billion. It is not free markets for the government to aid a big bank by putting taxpayers at risk.

Goldman Sachs was the direct beneficiary of the government’s decision to make good on the insurance that the big insurance company AIG had sold to Goldman Sachs on many mortgage-backed bond investments. AIG could not pay Goldman the insurance payments it owed them once the crisis hit; AIG had insured so many dollars’ worth of such bonds that they just did not have the money to make good on them all. In a free market that would have been tough luck for Goldman Sachs—they blew it; they bought insurance from a company that turned out to be in fact unable to pay—and they would and should have lost millions.

But we don’t live in a free market; the U.S. government paid the insurance that AIG owed to Goldman Sachs and others, so Goldman Sachs lost nothing. Where did the government get that money? Reach for your wallet, Charlie; they took it from taxpayers like you and me. That, to me, is an obscenity: the wealth of wealthy people at Goldman Sachs was protected by the U.S. government at the expense of non-wealthy Americans. It’s just wrong.

My point is that this is not free markets, and it’s not deregulation. It is government intervention in the economy.

I don’t know enough about specific people and companies and their relationships to be of any help about that, Charlie. What is clear is that we are far, far from free markets in the American financial industry. Banks continue very heavily regulated—more and more, as I understand it, because of the new Dodd-Frank legislation whose rules are being written now. And the whole financial industry is undermined by the government’s willingness to bail out big players with other people’s money.

I hope this helps, Charl. Write any time.

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