The Blog @ Spolitics

The Economist Stands Up for Capitalism

The Economist issued a defense of capitalism along with a warning against overreaction and ill-advised “corrections” to the current crisis.

Yet the failures of modern finance cannot be blamed on deregulation alone. After all, the American mortgage market is one of the most regulated parts of finance anywhere: dominated by two government sponsored agencies, Fannie Mae and Freddie Mac, and guided by congressional schemes to increase home-ownership. The macro economic condition that set up the crisis stemmed in part from policy choices: the Federal Reserve ignored the housing bubble and kept short-term interest rates too low for too long. The emerging world’s determination to accumulate reserves, especially China’s decision to hold down its exchange rate, sent a wash of capital into America. There was something of a perfect storm in which policy mistakes combined with Wall Street’s excesses.

Heavy regulation would not inoculate the world against future crises. Two of the worst in recent times, in Japan and South Korea, occurred in highly rule-bound systems. What’s needed is not more government but better government. In some areas, that means more rules. Capital requirements need to be revamped so that banks accumulate more reserves during the good times. More often it simply means different rules: central banks need to take asset prices more into account in their decisions. But there are plenty of examples where regulation could be counter-productive: a permanent ban on short-selling, for instance, would make markets more volatile.

Indeed, history suggests that a prejudice against more rules is a good idea. Too often they have unintended consequences, helping to create the next disaster. And capitalism, eventually, corrects itself. After a crisis investors (and for that matter regulators) seldom make exactly the same mistake twice. There are, for instance, already plans for clearing houses for CDSs.

Let’s hope Democrat lawmakers take heed.