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Commentary: No such thing as a free market

This article first appeared in the St. Louis Beacon: September 24, 2008 - Milo Minderbinder was a believer in free markets. He was the mess officer in Joseph Heller's WW II classic, Catch-22, who bought eggs at 7 cents apiece in Malta, then sold them at Air Corps bases for 5 cents each and still managed to make a profit. In fact, Milo's black-market egg business was so profitable that it metastasized into a trans-national syndicate that traded in all manner of goods and services and dealt as readily with Axis forces as it did with the Allies.

As a businessman, Milo was shocked and hurt when his friend, Yossarian, accused him of treason for contracting with the Germans to bomb his own base. It was done for the good of the syndicate, he explained, in which "everyone has a share." Being a devout free marketer, Milo of course bridled at the thought of governmental interference in his business, although he didn't balk at the free use of government aircraft to ship his eggs. The present chaos in the financial markets suggests that Milo was born ahead of his time.

To understand how we've arrived at the brink of worldwide fiscal collapse, you must recall Ronald Reagan's admonition that "government is not the solution to the problem, government is the problem." Once you've adopted that premise, it's a short ride to the conclusion that the way to make things work better is to get rid of pesky government regulation.

The free market, you see, is a self-correcting mechanism. By rewarding wisdom and punishing folly, the market promotes the general prosperity -- and with it, human progress -- with brisk efficiency. This is what Adam Smith referred to as the market's "invisible hand."

Problems arise, however, when investors are protected from the consequences of their unwise choices. People who are never called upon to pay the fiddler tend to dance recklessly -- a phenomenon known as "moral hazard." The surest path to utopia, then, is unregulated trade. This economic Darwinism allows genius to prosper and stupidity to perish, thus improving the plight of humankind.

I learned all this by taking economics as an undergraduate at Mizzou. That course was taught by a champion of sink-or-swim entrepreneurship who also happened to be a tenured professor at a state-supported university. Catch-22.

The movement toward deregulation gave financial institutions free rein to explore previously uncharted territories. For a while, this appeared to be a good thing. Sub-prime mortgages, for instance, yielded record profits for lenders while promoting home ownership among marginal borrowers. To spread the risk, these shaky loans were bundled into securities -- which compliant regulators rated as AAA -- then sold to gullible investors.

The general prosperity took a hit, however, when insolvent debtors began to default on the mortgages they couldn't afford in the first place, causing the whole thing to fall apart like the house of cards it always was.

In the resultant market correction, the common stock-holders took a bath while the firms in which they'd invested turned to the government for relief. For the big fish, unregulated capitalism is an all-reward, no-risk proposition. Nowhere is this principle better illustrated than in the government bailout of AIG, a deal that would have done Minderbinder proud.

The American International Group is currently rated by Forbes as the world's 18th-largest company. It consists of two divisions; traditional insurance and financial services.

The traditional insurance component is regulated by relevant federal and state laws. It remains well capitalized and is considered to be solvent.

The financial services division dabbled in the less regulated dimensions of the market. It invested heavily in exotic enterprises, including guarantees of complex debt instruments bought as investments by firms around the world. Many of these were backed by sub-prime securities. The losses sustained by this operation threatened to drag the whole company down the toilet.

The government recognized that AIG was -- to borrow on a by-now hackneyed phrase -- "too big to fail." If it collapsed, it could take the global financial market with it. Platitudes about the virtues of "free enterprise" and "market forces" notwithstanding, the government came up with an emergency $85 billion bridge loan for AIG. To secure the loan, the company issued the government warrants worth about 80 percent of the company's common stock.

AIG, in effect, self-collateralized. If the company prospers and repays the loan, its collateral will be quite valuable but unneeded. On the other hand, if it defaults and goes out of business, its collateral will be needed but worthless. So, in the event of default, the government will either have to eat an $85 billion loss or continue to pump public money into a failing private concern to ensure that the collateral it holds remains valuable enough to protect it against an $85 billion loss. Catch-22, check & mate...

The stock market enjoyed a brief rally last week on news that the government plans to create a permanent entity to buy bad loans from banks. Good work if you can get it. Perhaps, we can christen this new agency "The Institute of Moral Hazard."

You may be wondering how Milo managed to make a profit by selling eggs for less than he paid for them. The answer to that is fairly simple: He bought them from himself.

M.W. Guzy is a retired St. Louis cop who currently works for the city Sheriff's Department. His column appears weekly in the Beacon. 

M.W. Guzy
M.W. (Michael William) Guzy began as a contributor to St. Louis media in 1997 with an article, “Everybody Loves a Dead Cop,” on the Post-Dispatch Commentary page. In addition to the St. Louis Beacon and now St. Louis Public Radio, his work has been featured in the St. Louis Journalism Review, the Arch City Chronicle, In the Line of Duty and on tompaine.com. He has appeared on the Today Show and Hannity & Combs, as well as numerous local radio and television newscasts and discussion programs.

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