Connecting the Dots

In the mid 1990’s when the Japanese economy collapsed, the government of Japan was faced with difficult choices. The choice favored by free market economists was to let the once thriving capitalistic economy find an unfettered bottom, which would have most certainly caused extreme hardship for its citizens, a severe economic recession and some of its largest financial institutions and companies to fail. Instead, the government chose an interventionist policy keeping these companies and institutions alive, but sending the country into a deflationary cycle and an economic malaise from which it never really recovered. Was it the right decision?

Laizee-faire(roughly translated as “leave it alone” proponents fervently believe that government intervention is wrong. However, as any student of history knows, the Japanese have never had a laizee-faire, or completely free market economy. Clearly, leading up to World War II the Japanese operated under a nationalistic, imperialistic system. Following the war, the country created a public/private partnership which allowed the economy to thrive and prosper until the 1990’s.

The fact is that very few countries have ever had a truly free market economy. The closest the Untied States ever got to that ideal was in the late 19’th century when J.P. Morgan and other powerful businessmen created huge monopolies. Ultimately, the excesses of these monopolies and the absolute power that they exerted caused the government to break or “trust bust” them up. And, it should be noted that in the 19’th century the economy was fueled by its plentiful, untapped natural resources.

This week the United States Department of Treasury announced that it would, in essence, assume the control and liabilities of Fannie Mae and Freddie Mac. This is tantamount to one of the largest bailouts in our country’s history. For ardent “free market” economists, of which Treasury Secretary Henry Paulson is one, this might sound like heresy. The truth is that Fannie Mae and Freddie Mac were created by the government and have always had an implicit government guarantee. They were not created with the purpose of being independent, free market, private companies, but as government initiatives to expand home ownership. In fact, Fannie Mae was created in the 1930’s as one of the “New Deal” reforms.

To some, these government bailouts and the implicit bailout of the investment banks by opening and keeping open the Federal Reserve discount window might signal the death of free-market, non-government intervening capitalism. It is not! It is not because that principle never truly existed. There has always been a public/private partnership in this and every other capitalistic economy. As John Maynard Keynes advocated in the early part of the 20’th century, when that balance is achieved and the government appropriately intervenes, sustainable economic growth is achieved. If you allow a system of over-regulation and taxation it will stifle free enterprise. If you allow a system of under-regulation and lack of controls by the government the all too human trait of greed will create excesses and unsustainable bubbles.

The problem we face now is not that the government is intervening when it shouldn’t. The difficult economic circumstances we are experiencing result from the government not intervening when it should have much earlier. Irresponsible and unsustainable lending practices went unchecked and unregulated for far too long. Wall Street and major lending institutions operated without any checks and balances. The same institutions that fostered the ability and capacity of Enron and WorldCom to create relatively minor economic devastation moved on to the nation’s mortgage market and created much greater devastation.

In short, the government had no choice but to take over Fannie and Freddie. The consequences of their failure would be even more devastating to our economy and push the real estate market into complete failure. It is very likely the government is not done with its intervention. The nation needs to recover its economic balance and return to an effective and sustainable public/private partnership. The previous excesses will need to be paid for by tax dollars, which if implemented improperly will serve to stifle free enterprise. It is the ever present wheel of capitalism. It is the circle of life.