Harvard Business Review

Free markets are not ‘free’; the cost is eternal public (investors, shareholders, voters, etc.) vigilance, which requires investment of time, money and attention. When you notice the first symptoms of ‘bird flu' start ‘culling’ using powers like ‘recall’. If you ignore, the blight will spread fast causing incalculable destruction. .

What is the normal level of public vigilance? What percentage of voters vote? What percentages of shareholders attend Annual / Extraordinary General Meetings? What percentage of citizens exercise right to information and show courage to bring wrongdoings in the governments and corporations to light?

If the figures are dismal, the disasters like the present ones we face are inevitable.

Let’s remember ‘God helps those who help themselves’. Let us be ‘hawk-eyed’.

Really, the question is should health care be tied tied to jobs? The answer, clearly, is no. It's not good for people, and it's not good for business.

We seem so polarized in this country between left and right that we are not seeking win-win solutions. My European colleagues are not stressed out about health care in total, including dental and eye care. nor education - 2 key issues for a healthy, well educated population.

I just think we need to re-visit a more centrist, hybrid solution to these two essential components for a progressive society.

Great comments, Steve. As you recall, Milton Friedman and his disciples argued that free markets were the solution to every conceivable problem, and the torpedoes be damned. As we are currently realizing, America as a society -- and many people around the world -- have paid and continue to pay dearly for blind and sustained faith in Friedman's cruel notions, which have advanced plutocracy and diminished democracy. History will show that his ideas (and those of his followers, including Ronald Reagan, Margaret Thatcher, and my personal favorite, Augusto Pinochet) ultimately did more harm than good.

Yes, the Fannie debacle- and of course- the whole subprime mess- has been a cruel and dangerous exposure of the folloy of "Free market" approach. Of course there is no truly "free market" situation that exists anywhere once a business (national or international) reaches a certain size and level of interdepedency. Milton Friedman may have been right but only on a purely theoretical level since our complex financial institutions are ultimately intertwined with areas that are, in fact. reguated. What the right-wing has championed as "deregualtion" really means "let me take as much advantage of the current situation as possible, even if it hurts the ecomony in other sectors now or in the near-future."

Jon R.

Very interesting discussion. I think that such stories of the government helping Fannie Mae and Freddie Mac (and encouraging JP Morgan with Bear Stearns) only encourages people to analyze and understand their motives. I suppose I am pretty naive, but this subprime mortgage mess opened my eyes to the Fed and what sort of cartel it is. Now that Freddie Mac and Fannie Mae are in trouble, I too am learning what sorts of companies they are as well. When we are all prosperous, very few people question the science of the business world, but when times get rough (as they appear at present) we become privy to the dirty truths that got us through the prosperous times.

-Amit
www.brilliont.com/

I think the problem may have been mis-identified. Mr. Prokesch himself said the following:

"Societies elevate certain values and aspirations to the status of universal rights. In the United States, these include freedom from discrimination, a decent education, a chance to own a home, retiring with some measure of security, and now access to affordable, high-quality health care.

"Markets should be structured and governed to ensure that these universal rights take precedence over special interests, including business. And when the potential profits are insufficient to generate the private investment required to achieve society’s goals, yes, there’s a role for taxes."

When did owning a home or being able to retire become a right which should be ensured by the taxpaying base?

Beth, I totally agree with you. About the only thing we get for our tax dollars is a big military. I think it's about time that our allies paid their fair share, which might allow us to spend more on health, education, etc.

Jason, home ownership is already subsidized by taxes in a number of ways--most notably the income-tax deduction for mortgage interest. I would argue that taxes and regulations should be structured to discourage the kind of speculation in the housing market that helped drive up prices to ridiculous levels, which made it harder for people to afford houses and helped set the stage for the current financial crisis.

Regarding "retiring with some measure of security"... I would argue that most Americans DO feel that a combination of employer- and government-provided pensions should allow people to retire at some point in their lives. Given the demise of the employer-provided defined pension benefit and Social Security's woes, that point now seems to be receding, which undoubtedly will trigger a national rethink of the public and private pension systems in the not-too-distant future. It can't come too soon.

Steve I think that the very concept of a perfect market is wrong-headed, just as in evolutionary theory, some place too much emphasis on optimum design - which is purposiveful evolution through the back-door. The market is certainly not perfect - nor should we go for portfolios or policies that are predicated on that - rather we should have a dualist approach to the market - two world's - think of the archer fish and how that inhabits one world and aims a shot at a spider on the outside that inhabits another, a model that can work with the variables of these two worlds and correlate them, would "aim" at a best bet portfolio - we can use this model also with government and the free-market, consider them as a "perfect" or organized economic mdel and one that is completely all over the place - what joins the two is the observer, tracking the variables.A Markov tracking algorithm would do the trick of mediating between the predictions and expectations.

Steve
Perhaps on a completely different tack, it might be good to remember Marx and suggest that each system we create is based on feeing the interests of those in power. In a long economic era when the banks (and their owners) have undoubtedly had pre-eminent power to work their will out in this iteration of a market economy, is it any wonder that a whole system has evolved which privatizes gain and socializes risk.
For the whole game to keep on working, Fannie and Freddie are certainly too big to fail, as long as the presumption is that what is good for the bankers is good for America. Social Security, (the program which enshrines the power of the working class) will also be too big to fail, but if we keep bailing out the investor class, we will so debase the currency that the SS checks won't be worth much. Since the bankers can move money around in the international market but the workers can't, guess whose interests get porked as the taxpayers continue to bail out all the special interests?

You can't seriously be suggesting that the mortgage market, Fannie Mae and Freddie Mac are somehow examples of the failure of free markets. Fannie Mae and Freddie Mac were setup by the federal government. Congress created the subprime mortgage market in its desire to try to provide everyone (even those who really can't afford it) home ownership. They very idea that owning a home is somehow a "universal right" that should be provided to every person also helped create the mess by providing loans to people that couldn't afford to pay them.

Had the government kept its hands out of the market it may very well not have come to the crisis that it has become. Would lenders have given loans to people that most likely were going to default if they didn't have some guarantees from the government (in the guise of Fannie Mae, Freddie Mac, etc)?

The government's role should be no more than enforcing the contracts between parties and making sure that the marketplace is fair for all participants. When people make bad choices both as individuals as as part of corporations they must feel the effects of those bad decisions so that they aren't repeated. If the government swoops in to "save"

Perhaps it was less the guarantee of the government and more the ridiculously fat commissions that all the middle men were taking off the sub-prime mortgages (before reallocating the risks) that caused the current mess.
Dave - I find it misguided that implicit in your message that home ownership is not a universal right is that the irresponsibility (moral and economic) lies with the individuals who want better housing (and extended themselves beyond their means by ACCEPTING loans they did not qualify for) as opposed the the crooked bankers who OFFERED them the loans they did not qualify for (and then lied and profited from such).

Dave, I would argue that Fannie Mae's and Freddie Mac's hybrid status -- part private, part public but not fully either -- has been a big part of the problem. My guess is if they were one OR the other, they would have behaved more responsibly.

As for your comment "Had the government kept its hands out of the market it may very well not have come to the crisis that it has become..." The current mess is largely the result of the govenment pulling back its hands and allowing greed to prevail. If you recall, we once did have much more regulated financial markets -- a response to the failures of the banking system that the Great Depression exposed. But in the last 25-30 years, we have dismantled much of that regulation. And some of companies instrumental in undermining those regulations -- e.g, Citicorp -- are among those being hit the hardest by the current financial turmoil. Surprise! Surprise!

Regarding your comments about home ownership as a right... Again, societies decide what should be universal rights. And American society did decide that responsible citizens who worked hard should be able to afford to own a home. The experiences of the Great Depression and World War II contributed heavily to that belief.

We now seem to be in the same place with health care. If free markets are the answer, why are there 47 million people in the U.S. without health care coverage and millions more with inadquate coverage? Do you believe that people whose employers don't provide health care coverage and who can't afford it on their own don't deserve it?

There is a lot of political dogma being proposed as "fact".

Home ownership and healthcare are NOT guaranteed by our society and these goals routinely fail when put to the ballot with Americans.

America attempts to arbitrate "fairness" by enforcing our laws and our society universally agrees that "fairness" is the "American way".

American government participates in wealth redistribution makes things go awry.

Example: I eat vegetables, drink milk, exercise, avoid alcohol and do not smoke. I am a healthy guy.

If it were possible, would you forcibly take my excess health and give it to someone else? I earned my good health. What gives someone the right to take away my good health?

Thus, why is it justifiable to take my money to benefit another? You only take my money because you can. You cannot take my health (thank God), but I suspect some of you would if you could!

We seem to have a sub-society that is willing to exploit productive citizens to benefit unproductive citizens (expanding to non-citizens).

Isn't this what Rome did before the fall?

The comments above show an incredible amount of either denial or outright hostility to how these problems came to be. Fannie and Freddie were originally government programs designed with great intentions: provide low income people and minorities a vehicle to own a home. To this end the government allowed these companies to lend high-risk dollars and obtain capital at preferential rates over its competitors. Today, they own or securitize over half the mortgages in this country...and they are now in receivership by the United States government. They are in a 5 trillion dollar hole...their executives are mostly Democrat Party cronies who worked in Washington, where Reps like Barney Franks kept the gravy train going for 20 years! Any attempts to curb the excesses or create restraint were met with resistance..while greed will always be present and Wall Street shares some of the culpability, most of you are selling this sham that Fannie and Freddie's collapse was caused by free-market forces...please...

Mr. Prokesch:

Thank you for your recent article. You seem to suggest in your third paragraph a mutual exclusivity between free markets and asymmetric information. On the contrary, with perfect informational symmetry there would be no profit and no loss.

Consider for example the work of Lang et al. (1992), who found that market activity is a function of asymmetric information. The "dispersion of private information across traders has an impact on trading volume [i.e. market activity], but not on price".

Government intervention reduces market information asymmetry that serves to limit economic activity.

Sincerely,

Damon Douglas
Pharm.D./M.B.A. Candidate
Class of 2009
University of Maryland

Reference:

Lang LH, Litzenberger RH, Madrigal V. Testing financial market equilibrium under asymmetric information. Journal of Political Economy. 1992;100(2):317.

I thought the only "rights" that we, the people had are the ones concerning life, liberty and the pursuit of happiness.

The government intervention is all well and good, but no one knows if it will solve the problem. If it would then please, step in; but it will do nothing to change the human behavior that has created the problem. We as a society cannot live on credit. We cannot depend on the government to "save us" from our own stupidity.

The government should be limited to protecting our right guaranteed by the Constitution and the Bill of Rights. (emphasis on the period). Not saving the financial institutions, or any other company in free enterprise from the consequences of poor and rash business decisions.

Capitalism and all of the risks associated with it are what made this country great; and that is what will save it.

Your article misses the mark..if you truly think government health care can be easy to use, affordable, accessible, etc., you need to spend some time at a social security office.

You will see how time, money and dignity are rationed by the government.,,just the way health care will be administered. The only role a government can play in health care is rationer .. because once made universal, the healthcare system will overload way beyond the bureaucracies ability to deliver...just like social security today.

Stay away from government health care...it doesn't become more accessible, it becomes less accessible and more rationed and more difficult and more undignified as time goes on.

If you really want to help health care, have the government disband the American Medical Association. The AMA controls the supply of doctors (keeping the supply artificially low so demand can be high, thus expensive), university status of medical schools and ultimately the cost of health care.

Let the government build more medical schools, remove the artificial barriers to enty that exist for those talented students who are capable but can't get accepted in today's closed medical (AMA) controlled environment. Then pay for the cost of Doctors education and malpractice insurance...for a few years until the doctor is established...and stand back and watch the cost of medical care fall, the quality go up and the rationing of health care cease...a much better investment for the government than universal health care.

ssj. reno

Where are we as a culture now? An upswing or a downswing? This debacle proves the point that we are in a definite downswing that began with the 1960's ideals that government needs to have more control and regulation as a knee-jerk default fix. This is wrong. Again for the free-market nay-sayers they are missing the fact that increased greed (in the culture) is hard to anticipate the need for more regulation - especially if the level of greed is now higher than any time in the past century.

To fully analyze why this happened, the fall of the U.S. culture must be taken into account. Free-markets do need a little more regulation when greed increases, but the added regulation should be removed when greed decreases. When will this happen? How does one measure the level of greed? If one looks hard enough they can pinpoint the measurements.

For example, Jason's post above was clearly on point with the mentality of owning a home is now a "right" of every U.S. citizen. Look for the next level of misunderstanding when anyone who is living in the U.S. has the right of owning a home.

For a good brushup on historical lessons in economics, look to Thomas Sowell for clarity on these matters. I can't emphasize this enough!

Positioning the current crisis as a failure of free markets is easy to suggest but difficult to link. Fannie and Freddie failed, in part, because they were not free market entities. In fact, government intervention in the housing markets through these entities, no matter how well intended, contributed significantly to the problem along with a specific congressional mandate to encourage them into lower quality loans. The social goal of home ownership trumped a market solution. The credit rating agencies, whose role has been to AAA rate these ultimately toxic CDO's are part of a limited monopoly.
Of course, free markets are not the sole solution, especially when significant externalities exist. You could easily argue that low priced gas does not fully reflect the cost to society and hence the europeans tax it, in some way to reflect the total costs. There are decent solutions that can be prescribed, but they rarely involve government mandates which tend by there very nature to create as many problems as they solve. Even regulation has the law of unforseen consequences that free markets often avoid.
BTW, growing up in the British healthcare system would color your viewpoint on socialized medicine. Not negative or positive, but just very different than the US system. It's really a matter of tradeoffs we are willing to accept, not simply a matter that one approach is better than another.

Karl, I would argue that greed does not rise and fall. It's a constant. What rises and falls is our willingness to acknowledge natural human behavior and curb the excesses.

Today we have a crisis in the banking, brokerage and insurance industries. These are three of the most regulated industries in the US (and world). Furthermore, the financial sector is about to become even more regulated once Washington finalizes the terms of the proposed $700bn bailout.

I ask...is (more) regulation a good thing? There is no simple answer.

Perfect Free markets do not exist, but they are most certainly desirable. Imagine life without the free market, how and why would you compete for better quality of life.
Fundamental reason behind the current crisis is that companies like Fannie Mae and Freddie Mac floated general principles of market. Freedom comes with responsibility and it is certain that these companies with levers of government incentives didn't carry out those responsibilities well. Mike sums it up well in his comments if you earn your good health. What gives someone the right to take away your good health? Civil societies over the world need to strengthen the public and private institutes without weakening the free enterprises who made this progress and debate possible.

What Fannie Mae and Freddie mac Tell Us About Free Market
Nowhere is the process of Free market more apparent than in the financial sector. Many people believe that investors automatically will be protected from loss of assets by the operations of free and competivie markets. recent experience with events with Fannie mae, freddie Mac and the others in the financial markets support the notion that we are in a world of great uncertainty and inatability. The free market is at work. One possible response to the crisis is to put the proces on automatic pilot, holding the players to higher capital and liquidity standards to withstand shocks and encouraging them to invest in safer assets. The regulators must secure the integrity of the financial system and try not to protect any individual sector. there should be no protection for companies who do bad. The bank need to implement some accounting changes-take asset asset losses over time and recapitalize the assets. The American model of capitalism is severely damaged worldwide. It is a major turning point for the free market system.

In Response to Steve Prokesch September 25, 2008 5:16 PM,

I concede that the only point that I made which is up for discussion is whether greed is a constant or not. I concede that variances on greed are hard to measure, but I do agree with your statment of "...what rises and falls is our willingness to acknowledge natural human behavior." My other points do take it one more step in that what is also new here is the lack of acknowledgement of the fall of the U.S. culture, beginning in the 1960's which has shown some "thinking indicators" which never have been seen for over 2,000 years - let alone since 1776.

In summary, "The entitlement mentality so carefully cultivated by liberal acedemics, politicians, clergymen, and journalists continues to corrode the self-sufficiency that once defined the American charater" - Mona Charen.

This is a bit off the original topic, but I am continually baffled by the fear that the concept of universal healthcare engenders in the American public. (And yes, access to medical care should be considered a basic human right, regardless of your politics.) I'm an American expatriot who has lived in Canada for twenty years, and the system works beautifully here.

It is not "socialized medicine". Instead, doctors work on a fee-for-service basis, billing not the patient or insurance company, but a single third party: the Canadian government. Doctors can work as much or as little as they wish, and they run their own practices. It's known as "private practice with public payment." With the advent of the single-payor system here, per capita costs for healthcare dropped by one third. (In the U.S., private-care programs spend over 30% on administrative costs alone.) In addition, the system has been able to use its unified clout to negotiate far lower drug prices with the pharmaceutical companies.

Seriously, it is just so easy. You walk into your doctor's office (whom you have chosen, the government doesn't decide for you), show them your health card, and receive treatment of the highest caliber. Period. No forms to fill out, no co-pays, totally hassle-free. Canadian specialists are among the most highly-trained and best-equipped in the world. When my husband was diagnosed with cancer, he began treatment within two weeks, with cutting-edge technology, and was fully cured.

In the U.S., the AMA clearly feels threatened by the prospect of government-funded care. I must argue that physicians here do just fine. My friends who are GPs earn $250K per year, own million-dollar homes, and quit work at 5pm to play golf or spend time with their families. Specialists earn far more. M.D.'s may not become vastly wealthy here, but neither do they have to deal with all of the strictures and impediments to patient care that the HMO's have instituted in the U.S. Given the level of dissatisfaction I hear from physicians in the States these days, I can only assume that it's the lobbying of the vastly powerful insurance companies and Big Pharma that is blocking progress in U.S. healthcare. What you've wound up with is a thouroughly dysfunctional system that harms not only those unable to pay, but also those who can.

The Canadian system is not without its problems, of course, as the population grows and there is a shortage of doctors. But it seems to be a great deal easier to fix than the mess you've got down there. And yes, our taxes are higher, but on the other hand, employers don't have to pay for basic health insurance, which in turn benefits corporations and especially small businesses.

There was considerable opposition and fear when the Canadian Medical Care Act was instituted in 1968, with cries of "Socialism!" and "Communism--Never!" However, it is now a source of enormous national pride. How can a country consider itself "civilized" or "advanced" when its citizens are suffering or even dying simply because they can't afford to pay for medical treatment?

It's a myth that free markets exist anywhere. The concept of a free market without any regulation is like a child left to his/her own growth and maturity without any supervision or guidance by the parent or a guardian. There is no guarantee that the parental guidance will work for the good of the society, but it is almost certain that without it, there is a greater chance of the child going astray. How many of us would let the child in the family grow like this in the name of freedom?

Perhaps, it is too much to expect that the markets are capable of correcting the human behaviour and greed when it comes to money. The lack of regulation and the tendency to work with all the freedom unaccompanied by the accountability have all combined to produce the biggest financial meltdown we have seen unfolding. Mahatma Gandhi has said that there is enough on this planet to meet every human being's need but not for his greed. No market and no economic system can completely eradicate the human greed and that needs to be regulated. Also the tendency to spend beyond one's means and waste the planet's limited resources need to be curbed and go back to the conventional wisdom. Our mindset needs to understand and embrace that.

It's really strange that the biggest votaries of free markets are the ones now on the forefront of doling out the taxpayers' hard earned money and the government support to save the giant financial institutions. Probably, this is the shock we all need to wake up from our slumber and think afresh about the choices we need to make about our future.

It is easy to forget that our world is more about us, and less about systems. The method of free market economics is flawed, not because it is a flawed theory, but because we are involved with it. By itself, the market would regulate and take the necessary actions to maintain stability and steady growth. Our involvement brings flaws, the largest of which is greed. We cannot see what is best because our eyes are fixed on the wrong thing. The bottom line is not always the best indicator of the strength of a company, more often it is the purpose of the leaders that indicate strength.
Our human flaws will prevent a totally free market from ever succeeding in the long run, but without a free market our human ingenuity will also be repressed.