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WORLD REVIEW, AUGUST 18, 2009

Free market regulation


American politicians - Democrats and Republicans alike - began deregulating the U.S. financial system in the 1970s. Their premise was that regulations devised during the 1930s-specifically the Glass-Steagall system, which defined separate spheres for commercial and investment banks-would hinder the effective workings of contemporary financial markets.

The politicians and economists who advocated financial deregulation were right to think that the financial system in the late XX century has become infinitely more complex since the 1930s. The point they missed was that the financial markets cannot operate unregulated. The historical record makes this clear.

In the classic text "Manias, Panics and Crashes," Charles Kindleberger argued that the financial crises are a constant feature of unregulated financial systems.

Kindleberger argues that in an anarchic free market the rationality is not necessary the prevailing behavior. The panic, the irrational lending and investment illusions are human qualities that cannot be cured with lack of basic order and control.

Kindleberger found that from 1725 onward financial crises have occurred throughout the Western capitalist economies at an average rate of about one every eight and half years.

The history of financial crashes suggests a familiar pattern. They start with a fundamental change in the real world, such as a war or new technology, which creates new profit opportunities in some sectors. Investment expands, often fed by easy bank credit; before long, investment gives way to speculation, then becomes totally detached from reality and becomes "mania". Ultimately, it leads to a crash and "revulsion" in which investors flee falling markets. The recent crisis is not so different.

According Robert Pollin, a professor of economics at the University of Massachusetts-Amherst, the major factor for the crisis is the collapse of the U.S. financial system. It can be traced to the dismantling the Glass-Steagall financial regulatory system that was created in the 1930s precisely to prevent a recurrence of that era's economic disasters. Read Pollin's proposals for a new regulatory frame>>> Montreal Review


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