Don't Learn the Wrong Lessons

The current financial crisis gripping U.S. and world markets has many causes, and it will have repercussions for years and across too many financial sectors to list. For private investors, it's important to look beyond the current headlines to the underlying factors that have contributed to the crisis.

The current financial crisis gripping U.S. and world markets has many causes, and it will have repercussions for years and across too many financial sectors to list. For private investors, it’s important to look beyond the current headlines to the underlying factors that have contributed to the crisis. But it’s also important not to take the wrong messages from the current situation.

A recent Wall Street Journal article by Jason Dean reported on the international implications of the current financial troubles in the article. Dean wrote that “turmoil in the U.S. financial sector is…giving ammunition to foreign officials who question American economic leadership and oppose policies that follow the U.S. model.”

This thinking represents a major misunderstanding of financial principles. Free markets work when they are left alone. Problems are introduced into markets when restrictions are introduced, often when the U.S. government becomes too heavily involved in economic affairs.

Markets self-correct over time. Governments overreact. Today’s climate is due, in part, to government over-correction. With mark-to-market accounting now required in a temporarily illiquid market, we have massive failures of banks and other lenders who would otherwise have weathered the current storm, given that the vast majority of the loans they held prior to their failure were still good loans.

These aren’t simple concepts, to be sure, and often they are not well-understood by even those who are making economic and regulatory policy. What’s important to know is that government intervention in the free market system often brings unintended—and harmful—consequences down the road.

The lesson here is not that free markets fail. It’s that the U.S. free market system wasn’t allowed to do what markets do.

Mike Hennessy is Chairman and CEO of MJH & Associates. Click here for more Hennessy's Highlights