Free market ideas take back seat in financial crunch

Despite the fact that Treasury Secretary Henry Paulson is a dyed in the wool free market conservative, events over the last year has forced the Treasury Department to intervene in financial markets to a degree never before seen in American history.

That's the conclusion in this
insightful, informative article in today's Washington Post by David Cho and Neil Irwin. Allowing market forces to work, according to Paulson, would have plunged the nation into a credit crisis that would have affected all other sectors of the economy and led to a financial meltdown.

The resulting macro effect on the economy would have been catastrophic, say experts who see the reluctance with which Paulson intervened in crisis after crisis.

The fact is, the crisis has gone far beyond just the mortgage security credit crunch and is now affecting markets as exotic as student loans:

In April, Paulson helped the Department of Education set up emergency programs to ensure students could get loans as private lenders fled the business because of trouble in the credit markets. Education officials ramped up their direct lending, which some analysts say could reach $75 billion, and got new authority from Congress to buy loans outright from lenders.

And Paulson is well aware of the possible downside to this intervention; that financial companies will now take excessive risks because they believe if things go south, the feds will step in and bail them out:

"Paulson and his colleagues philosophically are free market people. But when things go wrong you just don't have a lot of choice," he said. "There has been a change in perception, that the government needs to play a more active role when we get into a financial crisis. . . . The question is to what degree do you say we won't do this again."

Paulson raised similar concerns in an interview. He warned that if the government always tries to bail out failing banks and companies, they will be motivated to take excessive risks. Others won't push themselves to succeed because they can rely on the government to bail them out.

Yet despite these convictions, Paulson said his hand was forced after the markets fell dangerously "out of balance" due to the credit crisis. Backing Fannie and Freddie, the country's two largest and most important financiers of mortgages, was the only way to keep the housing market from falling into turmoil, he said. Allowing Bear Stearns to fail could have led to a string of collapses at other huge Wall Street firms.

Read the whole thing for an eye opening look at who the government is bailing out and why.
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