Monday, September 15, 2008

Putting the "Free" back into the Free Market

A hard day in the office for some in London today

Although the collapse of Lehman Brothers is clearly a bit of a disaster for all concerned, including the 5,000 or so London-based workers who will probably loose their jobs, I do think this is one of the most sensible things to happen in the financial markets in the last year.

Until today, the emphasis has been on saving and bailing out every institution that failed. There did seem to be a limit to how much longer this could have gone on, regardless of whether it was right to do so or not. In the end there is even a limit to what the government can prop up and it seems that limit may at last be reached. (In this instance the limit has been reached by the US government but hopefully the principle will apply in the UK too).

To me at least, the whole point of a free market economy is that successful businesses flourish and failing businesses close. This may sound incredibly obvious and simple but in recent times this has been overlooked. This may not always be "fair" (especially on the many small cogs who work inside big machines) but it is an effective way of encouraging strong and well managed businesses. To prop up every failing bank seems to go against this philosophy and indirectly punish the more prudent banks who are less effected by this crisis. Why should rash instituions like Northern Rock be supported and carry on getting new business at the expense of banks who never needed state support ? This does not encourage good business in the long term if every bank knows it will be "saved" no matter what rash gambles it makes.

Therefore the failure of Lehman Bros, painful though it is, seems to be a return to reality. An old bank has sadly failed due to its more recent activities. Those who would have sought the services of Lehman Bros will now have to go elsewhere, potentially strengthening other banks. The buy-out of Merrill Lynch is another market solution that does not require taxpayers money.

Banks are now realising that the best way to save themselves is to help each other by putting money into a "lending pool". This seems to be a return to basic principles of banking and the free market and is far healthier in the long term.

The credit "cake" is shrinking at the moment and the weakest banks may struggle to survive. However the only real route to long term health is to let the market "weed out" the weakest whether by buy out or in hopefully only extreme cases bankruptcy.

Hopefully this can be a first step in turning the recent tide of "government support" in every situation from flooded houses built on flood plains, home insulation, failed holiday companies and even failed banks. These are just some of the areas attracting government "support" in the last year. In turn this must be paid for by taxes, which weaken the economy even further.

How ironic that it must fall to the Liberal Democrats to propose tax cuts and signal some end to the continued growth in state spending and the inevitable taxes that follow it.


cw-patriot said...

A very common sense commentary, Luis.

Ironically, the NYSE had a banner day today, supposedly because the government is talking about (once again) using taxpayer money to prop up failed mortgage companies.

One would think that investors would be smarter than that. Such continued use of taxpayer money to put a band-aid on bad decision-making is not only unfair, but it is also simply postponing 'reckoning day', and the end result will probably be significantly worse than it might have been if we simply allowed bad businesses to fail, and bad decisions to have consequences.

Thank you for the well-reasoned commentary.

Luis said...

Thank you Joanie.

I agree that these bail outs seem to be band aid solutions and simply postponing the day of reckoning.