Posted by: Dirk | October 11, 2008

Liberty in democracy vs liberty in capitalism

The financial crisis has put some very old questions on the top of the agenda, which many thought impossible barely 19 after the fall of the Berlin Wall. The question is the following: should private business be free (to do whatever it wants), or should it be regulated? This question is not posed by any politician or economist with influence in the media, but by the free enterprises themselves. Automobile manufacturers like GM, Chrysler and Ford in the US have recently asked (successfully) for government help in form of loans. Apparently, automobile manufacturers are cut off from loans, just like anybody else.

The enterprises blame it on the financial crisis, although they certainly committed grave errors in sticking to oil-guzzling vehicles for too long. Be that as it may, asking the government for help now comes down to the following question: should private enterprises be allowed to privatize their profits, while socializing their losses?

This question has been answered for enterprises in the banking and financial world. Those that are too big to fail are allowed to keep their profits while the losses are socialized. Most of the enterprises are privately owned, while there also are some government-owned firms like Freddie and Fannie, offering interest rates with the implicit understanding that the governments guarantees all deposits.

Until now, there was a clear division between the financial (Wall Street) and the real economy (Main Street). While it went unquestioned that the Fed regulated the price of credit and provided an institutional framework for banks, free markets ruled in the world of manufactures and services. This has led to some US-specific problems, especially in the telecommunications and software sector, where large network externalities work against a free market. The resulting monopolies occasionally give rise to firms that could also be considered too big too fail.

As the situation of the world economy deteriorates, calls for government loans to private enterprises will get louder. Giving direct loans to companies is a second best solution. What needs to be fixed is the financial system. Banks should fulfill their role and once again channel savings to firms, which then invest the money. A quick&dirty solution is not acceptable.

UPDATE 14/10/2008: Next week’s New Yorker picks up this topic:

Last week, in a potentially crucial move, the Fed announced that it would start buying billions of dollars in commercial paper—which means that it will be issuing short-term unsecured loans to corporations. The Fed has historically been the lender of last resort to banks. Now it’s becoming the lender of last resort to everyone.

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