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Government regulation, not free-market greed, caused this crisis

When government distorts incentives, the invisible hand can become a fist.

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Many observers, including most politicians, have blamed the ongoing financial crisis on the "free-market greed" supposedly unleashed by the "reckless deregulation" of the financial system. Such arguments are rhetorically powerful, but they don't stand up to scrutiny.

If they go unchallenged, however, they could hasten a "solution" that's worse than the problem. That's why it's so important to examine the record. What it shows is that government regulations and other interventions – not greed – are the major cause of our current problems.

Greed, or at least self-interest, is always present to some degree in the economy. Why has greed suddenly produced so much harm, and why only in one sector of the economy?

Firms are profit seekers, but they will seek it where the institutional incentives signal profit is available. In a free market, firms profit by satisfying their customers, investing wisely, and making prudent loans. Regulations, policies, and political rhetoric can change those incentives.

When the law either poorly defines the rules of the game or tries to override them through regulation, the invisible hand that makes self-interested behavior mutually beneficial may become more of a fist.

In such cases, "greed" can lead to problems, not caused by greed but by the institutional context channeling self-interest in socially unproductive ways.

To call the housing and credit crisis a failure of the free market or the product of unregulated greed is to overlook the myriad government regulations, policies, and political pronouncements that have both reduced the freedom of this market and led self-interested actors to produce disastrous consequences, often unintentionally.


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