Burned at the Stake

Walk on by
Walk on through
Walk till you run
And don't look back
For here I am
--U2

In the witch hunt to assign blame for the current credit crisis, a growing collective claims that the causes relate to excesses inherent to free markets. Through this lens, unfettered markets are seen as fostering long cycles of greed and fear that manifest in massive booms and violent busts.

Such perspective is interesting, given that few of us have observed truly free markets in our lifetimes. The free market construct, by definition, engages buyers and sellers in voluntary exchange. Market participants are fully responsible for gain or loss associated with their actions. Outside entities generally intervene to mitigate market processes or outcomes.

In reality, modern markets feature a variety of interventionist measures such as price controls, taxes, and regulations. Market interventions are often rooted in times of crisis such as large bankruptcies or wars. Because people tend to restrict information processing and centralize control during times of acute threat (Staw, Sandelands, & Dutton 1981), they are more likely to sacrifice freedom for security in the form of increased state control over markets during economic crises.

Over time, however, the state commonly converts event-driven interference into institutions that influence market behavior on a regular basis. The Federal Reserve, government sponsored enterprises such as Fannie Mae (FNM) and Freddie Mac (FRE), and the Federal Deposit Insurance Corporation exemplify institutions spawned from acute economic events but designed to routinely alter the course of market actions and outcomes.

As such, pinning recent credit turmoil on 'free markets' is nonsensical, since our markets have not been free for many years. The follow-on question is obvious:

"If free markets aren't at the root of the problem, then what drove the extreme credit conditions at the epicenter of the current crisis?"

Although market interventions are often proposed as stabilizing measures, critical thinkers need to consider the role of interventionism in amplifying economic and market cycles.

References

Staw, B.M., Sandelands, L.E. & Dutton, J.E. 1981. Threat-rigidity effects in organizational behavior: A multi-level analysis. Administrative Science Quarterly, 26: 501-524.