Thursday, October 20, 2011

Free Markets and the Greater Good

There is much noise in the media today that sounds like this: “Markets are right.  Government is wrong.”

That’s ridiculous.

Governments exist to regulate markets, because markets that are not regulated cease to operate.

It’s never a question of whether we should regulate our markets, but how we want our markets to be regulated.

A market cannot be allowed to regulate itself, because the market is focused only on itself.  It will not make choices “for the greater good”.  That is why we need government.

What is Wall Street but a giant market?  It is a very special kind of market, a financial market.  Finance plays a very special role in our economy, and therefor, in our society, and our politics.  It decides in some very important ways what work gets done, by whom.  An enterprise that gets funded competes.  An enterprise that cannot raise funds, closes.  Every enterprise gets its funds, ultimately, from its customers, who pay the price for value delivered by that enterprise.  Finance anticipates customer choice.

Finance is itself an enterprise, with customers that we call Investors.  Investors participate in the formation of a commercial enterprise in anticipation that the enterprise will attract enough customers of its own, who will pay enough of a price for enough of the items of value to be delivered by the enterprise to generate a flow of cash in which the Investors then share.

Financial markets arbitrate the anticipations of Investors relative to the ability of an enterprise to deliver value at a price and in volume, over time.

This is a function of critical importance that affects far more than the private lives of individual Investors and the enterprises competing for investment.  Investments, once made, are not easily unmade.  If badly made, they generate losses that ripple through an economy and impact the whole of society. 

Mistakes are inevitable.  That is how we learn, and through learning, how we discover new and better ways to do our work, and to build for ourselves a wealth of choices for living, and living well. But the costs of making mistakes cannot be allowed to overwhelm the benefits of learning.

A well-run financial market works best, in the long run, if it operates correctly to constrain these losses. 

But markets don’t exist for the long run.  They exist to make the sale.  The customer may not always be right, but the customer is always the customer.  They get what they will pay for, even if, in a larger sense, they are wrong to be paying for it.

This short term focus on making the sale does not always line up well the broader needs of the public good.  Which is why, from time to time, financial markets fail.

When they do, we all pay the price of their short-sightedness. 

The question is not, do we pay, or even should we pay.  The only useful question to be asking is, “what is the best way to pay?”

Is it better to prevent catastrophe, or to clean up after it?

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