Beware government 'help' that can actually hurt

Published in The Tennessean, May 9, 2010

Beware government 'help' that can actually hurt

by Richard J. Grant

Just when Tennesseans need it most, the law of supply and demand has been suspended. In the wake of the recent flooding disaster in Middle and West Tennessee, the state attorney general was quick to issue a news release warning Tennesseans “to be aware of potential price gougers.”

There is actually a state law that makes it “illegal to set prices that are grossly in excess of the price generally charged immediately prior to the disaster.” This presumes that there is someone in the state government with the omniscience required to make such judgments. There is not, but the law is enforced and companies have been forced to make repayments in the recent past.

Governments often display a tremendous disrespect for price and believe that merely by controlling prices they can control costs. But real life doesn't work that way.

With one of the water treatment plants shut down due to the flooding, the mayor of Nashville asked residents to conserve water. In a free market, the increased scarcity of tap water would be reflected in a rise of water prices. This would encourage people naturally to cut back on their least-valued uses of tap water. The higher prices would also attract water from other sources.

In 2008, Hurricane Ike disrupted gasoline supplies to Nashville and prices rose to around five dollars a gallon. The state government interpreted such price rises as gouging. But the real economic effect of higher prices is to make it worthwhile for suppliers to bear the cost of diverting supplies to places like Nashville where people were willing and able to pay higher prices rather than to have no gasoline at all. Had the state government succeeded in keeping prices down, the fuel crisis would have lasted longer.

Government interference with prices makes crises more likely. Government flood-insurance subsidies encourage overbuilding on flood plains thereby increasing the risk of loss and social dislocation.

The Federal Reserve keeps interest rates artificially low thereby encouraging investment in inappropriate projects and in excessive amounts. This affects the decisions of all individuals and businesses, especially those whose plans include large capital requirements.

Fannie Mae and Freddie Mac, by guaranteeing home loans and underpricing their risks, have caused homebuyers (and bankers) to underestimate the risks of borrowing, and have turned all US taxpayers into property speculators with all of the risk on the downside.

The problem in the housing market is leverage and unsustainable demand: negative equity results from borrowing too much and buying too much. That is the responsibility of the homeowner, but who encouraged the owner to borrow too much – by altering the price structure through tax breaks and credits – and perhaps to buy an excessively expensive house? The trouble in the derivatives markets was just a derivative of this.

Governments have also subsidized risk taking within financial institutions thereby encouraging excessive leverage (credit expansion) in our fractional-reserve banking system.

The FDIC, which contains the word “insurance” in its name but is not run like an insurance company, encourages carefree depositor behavior and increases the risk-taking tendencies of bankers. The FDIC does not correctly price its supposed insurance and so does not appropriately discourage risk-taking. Its main function is to give the illusion of safety while removing market discipline, and then to close failing banks when its policy side effects begin to emerge.

Just as good people do us a service by telling us the truth even when the truth hurts, good people do us a service by charging prices that reflect the truth about resource availability and the relative demand for those resources. In a time of genuine emergency, good people step in and give of themselves and of what they have. Governments, to the extent that they have policing and emergency services trained and ready, can be lifesavers. But we must always be vigilant against pushing governments inadvertently to take actions that make things worse.


Richard J. Grant is a professor of finance and economics atLipscomb University and a scholar at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail:rjg@richardjgrant.com

Copyright © Richard J Grant 2010

Popular posts from this blog

My latest in Business Day on inflation & currency value

New articles on Substack:

How limits to economic freedom are behind SA’s failures