Economic Liberalism (part 2)

I would like to start part 2 of this discussion that was brought up recently by Junk Bonds. (see post of Nov. 12)

It is clear now that the system is broken and the attempts by our authorities to stem the crisis is both laughable and anguishing. In the future there will be many versions of this historic period and the causes leading up to it. Of course the reasons for this economic breakdown are varied, but the one enabler for this credit bubble and now bust was the allowance of increased leverage ratios by our banks and lending institutions. I hope the details of of H. Paulson's role in lobbying the bank regulators to allow for increasing leverage is someday flushed into the open, but for now I will assume the man is just evil.

So the question remains if the U.S. as well as Canada have the appropriate regulators and if not why not? The clearest example of an area where the free markets seem to fail citizens is health care. I am proud of the universal Canadian health care system in spite of sporadic inefficiencies. On balance, the system here seems to work, whereas in the U.S. the divide between the haves and have nots keeps worsening. Another area where the markets aren't so kind is care of the elderly.

Today I read a great (but long) post on Mark Thoma's blog with this headline quote that caught my attention: "This monstrous conceit of contemporary economics has brought the world to the edge of disaster"

From Mark Thoma:

When it comes to our present predicament, I don't blame all economists, but some did push the non-government intervention line too way too far. There's a big difference between interfering in markets that are functioning well, and regulation and intervention designed to ensure that the conditions markets need to perform well are in place.

Markets need a supporting institutional structure. Without such a structure, markets can fail and in some case, as we are seeing, they can crash and burn. One of the problems is that many people - economists - assumed that the institutional structure would be self-regulating. If there are agency problems, lack of transparency and informational differences, monopoly or monopsony power, property rights that are not well-defined, and so on, somehow the market would force institutional changes in the structure of the markets that would bring about an optimal outcome (meaning the markets approximate competitive ideals). However, when it comes to self-correction, resources flow fairly well between markets to correct imbalances - that type of self-correction is evident and I do not doubt that it works. But institutional self-correction - correction of the incentives that determine where resources flow - is another matter.

The assumption that the institutional structure is self-correcting was one of Greenspan's failings, a failing he has recently acknowledged. Markets don't always provide, on their own, the institutional structure needed to ensure their successful operation.

For the full essay link. So now that Obama has been elected with a platform that had included health care reform, will the US have the capital left to force the necessary changes? I see that Citigroup today has temporarily managed to survive with more government handouts to the tune of $300B. This is getting ridiculous seeing as GM/Ford were only asking for $50B! Doesn't this allow those speculators to line up the next victim? Short Morgan Stanley anyone?