Dancing with Fred or Frankenstein: Free Markets, Socialism, and the Bailout

Washington’s $700 billion bailout plan is making a lot of people unhappy. The Troubled Asset Relief Program (TARP), as the implementation of the Emergency Economic Stabilization Act of 2008 has come to be known, seems to be morphing unpredictably.

Originally, TARP was supposed to help stabilize financial institutions by buying from them what are euphemistically termed “impaired assets”—that is, gobs of unmarketable, even worthless, financial junk. This plan was abandoned within days. Shortly after TARP was unveiled in September, $250 billion of capital was “injected” into banks, sometimes by purchasing shares of stock, other times via loans. On Nov. 12, Secretary of the Treasury Hank Paulson, who was placed in charge of TARP, announced that the focus of the program was shifting to an attempt to facilitate consumer loans. What Paulson will do tomorrow is anybody’s guess.

Meanwhile, as Paulson and associates tinker with TARP, the stock market has sunk to new lows and the economy continues to deteriorate. In fairness, we can’t say that we weren’t warned that this might happen. President Bush plainly stated on television that things would get worse before turning around. Secretary Paulson told us that the $700 billion rescue/bailout plan might not work.

Now the critics are calling for Paulson’s head. Among other things, they say he’s incompetent. This is both true and untrue. As top banana in a hugely successful investment bank, Paulson showed himself to be highly competent. He is NOT an incompetent person or financier. That said, he has proven incompetent to find a way to use $700 billion to stabilize the American economy. Well, surprise, surprise. Yes, Paulson is “incompetent” in this regard, but vilifying Paulson for not being able to save the economy makes no more sense than condemning him because he can’t flap his arms and fly. Nobody—from the eminently wise Paul Volcker to Nobel Prize-winning economists to the world’s greatest genius—could fix this economy, even if they were given ten times the money placed at Paulson’s disposal.

Last week, I asked my Economics 101 class why they thought Paulson was having such a hard time pulling us out of our economic tailspin. A hand went up and a young man said something like, “Because he doesn’t have enough knowledge to know how everything should fit together.” Bingo! That’s it in a nutshell.

Any economy, but especially one as large as ours, involves millions of people, billions of daily decisions, and countless individual assets, contracts, obligations, abilities to pay, etc. What is the “right” price for each asset? Which contracts and obligations take precedence? What is everything worth, and what companies are most worth saving? Answer: Nobody knows, and nobody can know. This is the fatal flaw in socialism. Socialism doesn’t work—it CAN’T work—for the fundamental reason that only a market pricing mechanism can bring supply into balance with demand and rationally coordinate the economic activities of millions of persons.

To use an analogy, the difference between central planning and a market-based economy is comparable to the difference between the Frankenstein monster and Fred Astaire. Nobody planned or built Fred Astaire—his grace, coordination, and fluid motions came naturally. That’s the way a market economy works, with prices continually adjusting so as to coordinate the actions of millions of people. By contrast, when Dr. Frankenstein tried to artificially construct a man, assembling the different parts and patching them together, he produced something hideous. It resembled a man (two arms, two legs) but the creature’s movements were slow, clumsy, pathetic, and ultimately destructive. Such is the nature of a socialist economy, where necessary adjustments are slow, supply and demand are uncoordinated, production is herky-jerky, and economic progress is pathetic.

Socialists don’t understand that you can’t MAKE economic activity be coordinated; you have to LET it coordinate itself through market prices. This is Socialism 101, and it is why Paulson and any eventual successors will not be able to put the fallen Humpty Dumpty of the American economy back together with top-down planning. Only markets developing themselves from the ground up can accomplish this.

TARP is doomed to fail. There is a silver lining in this wretched political experiment, however: As Americans see TARP degenerate into a spectacle of corporate lobbyists trying to grab what they can from the government piñata, resistance to future bailouts will grow. And as they see that government planning solves nothing, producing nothing but political inequities, maybe, just maybe, they’ll be willing to support market-based solutions.