Free Market Failures

The parents at our kids’ school were doing their best to remain calm this morning.  But there was clearly a buzz about the financial markets.  One woman works for Merrill and was in a hurry to get downtown to see if she still had a job.  Another woman said her husband was a portfolio manager at Smith Barney -- “thank God,” she added.  Both had been up since 5:00 am, watching CNBC for any news about what’s next.

To put things in a nutshell:  Bank of America just acquired Merrill Lynch - otherwise Merrill would have gone belly up into bankruptcy.  (Like buzzards eating carrion, B. of A. bought troubled Countrywide Financial a few weeks back as well).

Lehman Brothers filed for bankruptcy yesterday.  Unlike Merrill, Lehman couldn’t find a buyer and the government refused to prop them up with tax payer money.

Clearly the federal government is worried about the markets.  Though, they let Lehman fail.  Just a few weeks ago they helped bail out Bear Stearns by arranging a buyout by JP Morgan Chase.  And in an even bigger federal bail out, the government recently took over mortgage giants Fannie Mae and Freddie Mac.  (Note: our allegedly “free” markets require guidance, regulation, support, and policy guidance in myriad ways.  “Free” markets, strictly speaking, are a myth).

At this point, no one is sure whether insurance giant AIG will stay solvent.  The New York Times quotes one investment banker saying that he’s never seen anything like this in the 35 years he’s worked on Wall St.

CNBC commentators are trying to get to the bottom of it all.  What happened?  What’s next?  Is this the end or the beginning of a Wall St. earthquake?  What about all the people who have insurance policies, or money on deposit or invested with the big banks?  Who’s to blame?  

Most analysts agree that there is not enough regulation.  A former CEO of Solomon Brothers said, “When there aren’t enough rules, hubris and greed will lead businesses to take unwise risks in an attempt to maximize profits.”  And most analysts agree that there is not enough disclosure.  Large companies are “opaque” not only to average Americans, but even to analysts.  One analyst admitted that, until this weekend, no one knew how bad Lehman’s balance sheet was.  So much for the “transparency” that was supposed to be the lesson we learned from Enron.

Now is a good time for all of us to listen and watch and learn.  What would it mean to live wisely in a free market economy?  I do not even pretend to understand the complexities of all the mechanisms that enable our financial markets to work.  But I do know that there is a big difference between living wisely and living foolishly.  And taking enormous risks with other people’s money in order to maximize profits is not wise.  Encouraging the public to buy more than they can afford is not wise.  Nor is it wise to structure a business so as to deceive investors and the public by putting out financial statements designed to deceive rather than inform.