The financial crisis started when large numbers of people were unable to make payments on their home mortgages. Banks had loaned too much money to people who were unable to repay the loans. This happened because the government required banks to make loans to underserved people. Underserved people are people who would otherwise be unable to get a loan. In other words, underserved people are people who are unable to repay loans. The banks made loans to people who could not repay the loans because the government required them to.

The government regulated financial institutions to make sure that the financial institutions were not taking too many risks. But how did the regulators measure risk? The regulators checked the credit ratings of borrowers. So the consequence of regulation was that financial institutions were required to make loans based on credit ratings, and the power to decide who was eligible and who was ineligible for loans was shifted from the banks to the credit rating agencies. Meanwhile the government refused to license any new credit rating agencies, thus giving the existing credit rating agencies a monopoly and preventing competition between credit rating agencies. For business loans, the credit rating agencies were paid by the borrowers, who wanted good credit ratings, so the credit rating agencies had an incentive to give good credit ratings rather than accurate credit ratings. By requiring banks to lend based on government approved credit ratings, the government forced all banks to have the same lending standards. Banks have no incentive to develop better lending standards because any bank which tried to develop better lending standards would be punished by the regulators.

In a free market, every bank would develop its own lending standards, and the banks with the best lending standards would be rewarded with the highest profits. By requiring all banks to use the same lending standards, the government reduced competition in banking. If the government prevents banks from competing in honest banking, then the only thing the banks can compete in is fraud.

The book Engineering the Financial Crisis: Systemic Risk and the Failure of Regulation by Jeffrey Friedman and Wladimir Kraus says the government imposed uniform lending standards on banks, and calls this regulatory homogenization.

Credit ratings are absurd and would probably not exist in a free market. If someone has an accurate method of predicting the probability of default for individual borrowers, the best way to profit from this information is by making loans to low risk borrowers whom other lenders have erroneously classified as high risk. The information should not be sold or made public because the information needs to be kept secret from competitors. So if a credit agency is selling information instead of using information, then the information is probably useless, inaccurate, and worthless. So it does not make sense for banks to buy credit ratings unless the government requires banks to buy credit ratings. For publicly traded corporate bonds, the best rating is the current price.

During the financial crisis, investors were unwilling to buy stock or bonds in or make loans to many financial institutions, because no one knew what the financial institutions were worth. No one knew what the financial institutions were worth because the financial institutions used a bad accounting system. The financial institutions used a bad accounting system because the government required them to. A free market should not have an official, mandatory, government sanctioned accounting sustem; but should have multiple accounting systems competing with each other.

Contradictory government regulations exacerbated the problem. The government required banks to refrain from making high risk loans, and the government required banks to make high risk loans to people favored by the government. If a bank complied with either one of those rules, the bank would have been in violation of the other rule. It is impossible for a bank to comply with both rules, but it is possible for a bank to fraudulently pretend to comply with both rules. So the effect of the government regulations was to require banks to lie, which increased the uncertainty in the financial markets, which exacerbated the financial crisis.

If a company issues stock, and then the company has problems, the company will reduce the dividend and the stock price will go down, but the company is not bankrupt. But if a company issues bonds, and then the company has problems, the company cannot reduce the interest payments on the bonds; the company is bankrupt. The more leveraged the company is, the more vulnerable the company is. If most companies are highly leveraged, then the whole economy is more vulnerable; a small economic disturbance can cause a large number of corporate bankruptcies.

The government encourages companies to be leveraged. This destabilizes the economy, and causes a financial crisis to be greater than it would be in a free market.

The government encourages companies to be leveraged by giving a tax credit for interest payments, but not for dividend payments.

The government encourages companies to be leveraged by requiring banks, insurance companies, and pension funds to buy bonds instead of stocks. If a company issues stock, and if the company has unexpectedly high profits, the company shares the profits with investors; and if the company has unexpectedly large losses, the company shares the losses with investors. If a company issues bonds, and if the company has unexpectedly high profits, the company keeps the profits; but if the company has unexpectedly large losses, the company shares the losses with investors. From the company management's point of view, bonds and loans make everything into a game of heads I win, tails you lose. But from an investor's point of view, bonds are a bad investment because bonds are almost as risky as stocks, but much less profitable. If the government did not require banks, insurance companies, and pension funds to buy bonds; there would be fewer buyers of bonds, so companies would issue fewer bonds, so companies would be less leveraged.

The government also encourages companies to be leveraged by providing extra benefits to companies which are teetering on the edge of bankruptcy. The government does not want companies to go bankrupt, because bankruptcy causes workers to lose their jobs, and rising unemployment makes the government look bad. So the government sometimes tries to help almost bankrupt companies by forgiving unpaid taxes; not imposing fines for environmental, worker safety, or consumer safety violations; discouraging lawsuits against the company; giving the company special contracts with the government; giving the company low interest loans; or giving the company a subsidy.

So companies have an incentive to operate on the edge of bankruptcy, and the easiest way for a company to push itself to the edge of bankruptcy is to become highly leveraged. But the more companies operate on the edge of bankruptcy, the more likely the economy is to suffer a financial crisis.

If a business builds a factory, the business can get the money to build the factory by selling bonds, or by selling stock. Investors in bonds and investors in stocks both deserve to earn something from their investments. But the government, in its infinite lack of wisdom, has decreed that returns to stockholders are profits, while returns to bondholders are costs. Therefore, according to stupid government mandated accounting rules, a business with low leverage is more profitable than a highly leveraged business. Meanwhile the government, cheered on by socialist demogogues, attacks businesses which have high profits, which means the government is attacking businesses which have low leverage. This encourages businesses to have more leverage, which makes the economy more prone to financial crises.

Most loans, including bonds and mortgages, have fixed interest rates and fixed durations. If economic conditions change, a loan may no longer make sense, but the loan contract cannot be changed. This could drive one or both parties into bankruptcy, which could compound minor economic problems into a major economic crisis. When businesses choose to finance themselves through loans instead of through stock, that destablizes the economy. The more loans there are in the economy, the more unstable the economy is. The government's policy of allowing a tax deduction for interest payments by businesses and for mortgage interest payments by individuals encourages businesses and people to borrow more money, which destablizes the economy.

I have never understood why socialist demogogues think it is evil for a business to steal from workers and customers and give the money to stockholders, but it is good for a business to steal from workers and customers and give the money to bondholders.

Suppose a business is well run and profitable. Then suppose someone does a leveraged buyout of the business and strips assets until the business is almost bankrupt. The business now becomes eligible for tax breaks and subsidies. In effect, the government is subsidizing leveraged buyouts and asset stripping.This makes it profitable to do leveraged buyouts of well run businesses and strip assets until the businesses are bankrupt. Asset stripping would not be profitable without government subsidies. But businesses which are stripped of assets lack the reserves to survive hardships, and may be forced into bankruptcy by minor difficulties. This makes the whole economy more prone to economic crises because minor economic problems may bankrupt many businesses, which amplifies the minor economic problems into a major economic crisis.

Since the government encourages businesses to operate on the edge of bankruptcy, it is profitable to restructure well run businesses into almost bankrupt businesses. This diverts resources out of operating real businesses and into leveraged buyouts. Investors find it is more profitable to invest in leveraged buyouts than in real businesses. Talented people find they can earn higher incomes doing leveraged buyouts than running real businesses. This diversion of resources out of the real economy weakens the real economy. The whole society is poorer because resources are diverted out of productive uses into unproductive uses.

The government also weakens the real economy by imposing high taxes. If a business becomes more efficient, the business becomes more profitable, but the government takes more taxes. If a business becomes less efficient, the business becomes less profitable, but the governments takes less taxes. High taxes mean that businesses are not rewarded for being well run, and are not punished for being badly run. High taxes are the equivalent of a government subsidy for corporate waste. High taxes cause business managers to spend more time and effort \trying to avoid taxes, which means that business managers spend less time and effort trying to increase quality or reduce costs.

A well run business is profitable. A badly run business is unprofitable. By attacking profitable businesses, the government is demanding that all business be badly run. When all businesses are badly run, the whole economy is weaker.

The government subsidized home mortgages through income tax deduction and by guaranteeing mortgage bonds. The bigger your mortgage, the bigger your subsidy. So people tried to get as big a mortgage as possible, so they could get as big a subsidy as possible. But someone with a huge home mortgage is living on the edge of bankruptcy. If everything does not go perfectly, they will be unable to pay the mortgage. So the government's policy of subsidizing home mortgages causes people to live on the edge of bankrupty, which makes the economy more susceptible to financial crises.

Many years ago, if you borrowed money from a bank, the bank actually loaned you the money. If you paid the loan back, the bank made a profit. If you did not pay the loan back, the bank lost money. Since the bank's profitability depended on loans being paid back, the bank was very careful who they loaned money to. The bank refused to lend to deadbeats.

But today, if you borrow money from a bank, the bank does not actually lend you any money. Instead the bank arranges a loan for you. The money which is lent to you actually comes from insurance companies and pension funds which buy collateralized mortgage obligations and other shares of other loan pools. The bank collects a fee. The bank collects its fee regardless of whether or not you pay the loan back. So the bank does not care whether you pay the loan back or not. The bank is happy to lend to deadbeats.

So why did the banks change? Arranging loans is obviously less risky than lending money, so some banks might have chosen to stop lending money in order to reduce risk. However, lending money is usually more profitable than arranging loans, so most banks would probably choose to continue to lend money. The real reason the banks changed is because the government regulators demanded it.

The regulators are responsible for protecting depositors. If the bank uses depositors' money to make loans, and if the loans are not repaid, then the depositors' money is lost. The regulators want to prevent this. Making loans is risky. The regulators want banks to reduce risks. So the regulators tell the banks to stop making loans, and buy safe government guaranteed bonds instead. If the banks continue to make loans, the regulators punish the banks. But since the banks are no longer lending money, the banks no longer care whether or not loans are paid back. So the attempt by the regulators to reduce risk actually increases risk.

Risk always exists. The economy is strongest if risk is spread around fairly and if risk is clearly visible. But the government regulators demanded that banks and insurance companies reduce risk. It is impossible to make risks go away. So the only ways the banks and insurance companies can reduce risk is to either dump risk on to someone else, or else hide risks from the regulators. If everyone is trying to dump risks on to everyone else, then risks will become concentrated on whoever is too weak to refuse. So the government's policy of requiring banks and insurance companies to reduce risk had the effect of making risk less visible, and of concentrating risk on the people who were least able to withstand risk. This made the economy less stable and more susceptible to a financial crisis.

AIG was bankrupted by credit default swaps, which are insurance for bonds and loans.

But why did so many people buy so much insurance for loans and bonds?

If I was a banker, I would not insure loans. If I thought the borrowers would repay the loans, then buying insurance would be a waste of money. If I thought the borrowers would not repay, then I would refuse to lend them money. If I was an institutional investor or mutual fund manager investing in bonds, I would not buy insurance. If I thought the bonds would not default, insurance would be a waste of money. If I thought the bonds would default, I would not buy the bonds.

If the insurance company thinks the bonds will default, why is the insurance company insuring the bonds? If the insurance company thinks the bonds will not default, why doesn't the insurance company buy the bonds instead of insuring the bonds?

If the financial markets were efficient, then insurance would cost more than insurance is worth. Suppose you want to insure a diversified portfolio of bonds for a long period of time. The insurance company needs to collect more money in premiums than it pays out for defaults. The cost of insurance must be greater than the benefits of insurance, or else the insurance company will go bankrupt.

Suppose an ordinary person has a bank account. If the bank goes bankupt, the ordinary person will lose the money in the bank account, unless the bank is insured. But if the bank is insured, the bank will have to pay insurance, which means the bank will have less money to pay interest, so the ordinary person will receive less interest on the money deposited in the bank. If the ordinary person divides the money among 1000 different banks, then the ordinary person will be better off if the banks are uninsured, because the extra interest payments the ordinary person receives will be greater than the money lost from the occasional bank failure. But if the ordinary person keeps all the money in one bank, then the ordinary person is better off if the bank is insured, because if the bank goes bankrupt, the ordinary person will lose everything.

Insurance is a poor substitute for diversification. Insurance does not make sense except when diversification is impractical. An ordinary person cannot easily diversify home or health, so insurance makes sense. But a bank ought to have a diversified loan portfolio, so insuring the loans is stupid. A mutual bond fund ought to be diversified, so insuring the bonds is stupid.

Even if an insurance company is stupid enough to sell insurance below cost, insurance still does not make sense. If the insurance company has low premiums, then the the insurance company is not collecting enough money, and therefore will be unable to pay any claims. Insurance which does not pay claims is worthless.

So if loan and bond insurance is such a stupid idea, then why did so many people buy so much loan and bond insurance? Because the government required them to. Government regulators told pension funds to buy insured bonds. Government regulators told banks to insure the loans.

Banks were regulated according to the Basel II Accord. The Basel II Accord says that banks which buy credit default swaps need less capital than banks which do not buy credit default swaps. So banks were buying credit default swaps to reduce their capital requirements. Banks were buying credit default swaps because the government punished the banks by demanding more capital if the banks did not buy credit default swaps. The banks were buying credit default swaps to avoid punishment by the government regulators, not to insure loans.

If you want insurance, you want insurance from a reputable company which pays claims promptly, even if that costs more than insurance from a disreputable company. But if you do not want insurance, and are only buying insurance because the government requires you to buy insurance, then you want the cheapest possible insurance, even if that means buying insurance from a disreputable company which does not pay claims.

The banks were buying credit default swaps to satisfy the regulators, not because the banks wanted to insure loans. So the banks wanted cheap credit default swaps instead of credit default swaps from reputable insurers. Insurers operating on the edge of bankruptcy could provide cheaper credit default swaps than profitable and stable insurers. So banks preferred to buy credit default swaps from disreputable insurers.

But a minor economic problem could cause many disreputable insurers to go bankrupt, which would eliminate the credit default swaps of the banks. Without the credit default swaps, the banks require a lot more capital, but it is difficult for banks to raise capital during a minor economic problem. A bank with insufficient capital is bankrupt. So government regulations have the effect of multiplying a minor economic problem into a major economic crisis.

"Legal tender for all debts" is written on american paper money. When America first became an independent nation, the new government did not have enough gold to pay for the war, so the new government paid soldiers and military suppliers with paper IOUs. The soldiers wanted to use the paper IOUs to buy food and things for their families. The military suppliers wanted to use the paper IOUs to pay their workers. But the storekeepers and workers refused to accept the paper IOUs. So the government made laws requiring everyone to accept paper IOUs as gold. Then the military suppliers could promise to pay their workers in gold, then actually pay the workers with paper IOUs, and if the workers objected, the workers could be sent to jail. The government required and still requires everyone to pretend that paper IOUs are gold. For example, suppose I sign a contract or otherwise promise to give you a one dollar gold coin. Then suppose I give you a paper one dollar bill. If you say that a paper one dollar bill is not the same as a one dollar gold coin, you could go to jail. The law requires you to pretend that the paper one dollar bill is a one dollar gold coin.

"Legal tender for all debts" means that everyone has permission to break contracts which require the payment of gold. Any business which promises to pay gold to workers can break its promises to workers. Anyone who borrows money and promises to repay in gold can break his promise to repay.

The government rarely prosecuted people for demanding gold, except during the administration of Franklin Roosevelt. But if someone if someone filed a lawsuit demanding the gold which they were promised, the courts would refuse to hear the case and the government would do nothing.

I think the government should not have required and should not still require people to pretend that paper money was gold. The government needed to persuade people to accept the paper IOUs as money, but this would not have been a problem if the government had accepted the paper IOUs as payment of taxes.

The government distorted reality by requiring people to live in a fantasy world by requiring people to pretend that paper money is gold. Likewise, the government distorted reality by requiring banks to pretend that phoney accounting was real. The free market depends on reliable information. When the government suppresses accurate information and propagates incorrect information, the financial markets become less stable.

Government regulation usually causes people to lose touch with reality because government leaders are usually out of touch with reality.

In unregulated financial markets, investors ask how risky a company is. Investors avoid risky companies, and avoid companies opaque companies because opaque companies are more likely to have hidden risks. In a regulated financial market, investors ask if a company has been approved by the government. In an unregulated financial market, companies try to avoid risk. In a regulated financial market, companies try to hide risk instead of trying to avoid risk. Thus regulation makes financial markets less transparent and more risky.

If an investor does not understand the accounting of a company, the investor will probably not invest in the company for fear of unknown risks. If a government regulator does not understand the accounting of a company, the regulator will probably declare that there is no problem. If the regulator says the accounting is incomprehensible, the regulator will have more hassles and stress, and other people may think the regulator is stupid. An investor assumes that companies are risky until proven otherwise. A regulator assumes that companies are not risky until proven otherwise.

Regulation gives bankers an incentive to game the system by hiding risks instead of avoiding risks. Clever people find that the highest paying career consists of creating new ways to hide risks from regulators. The financial markets become less transparent because risks are more hidden. Lack of transparency destablizes financial markets because in the absence of reliable information, rumors cause wild price swings.

The financial markets work best when risk is spread around and shared. Any investor who refuses to accept a fair share of risk will be shunned by other investors. But government regulators demand that banks take as little risk as possible, by shifting risks to others whenever possible. In unregulated financial markets, investors who make unreasonable demands are shunned. But in a regulated finacial market, government regulators who make unreasonable demands cannot be shunned. The result is that in regulated financial markets, risk becomes concentrated and hidden instead of spread around and visible like in an unregulated financial market.

Some people say the government caused the financial crisis by creating the bubble by setting short term interest rates too low. I am not convinced of this. Economic theory predicts and the historical record shows that when the government mandates a price below the market price, the result is a shortage and a black market. If the government had set short term interest rates too low, the number of people and companies wanting to take out short term loans should have increased, and the number of people and companies willing to make short term loans should have decreased. This should have resulted in long lines of people waiting to get a short term loan from the few people willing to make short term loans, and an increase in black market lending such as loan sharking. The government could reduce short term interest rates by increasing long term borrowing and lending the money for short terms, but this would have caused long term interest rates to rise. The government could have printed money and loaned the money short term, but this would have caused inflation; There was mild inflation during the bubble, so I think the government did this a little bit, but not a lot. So I do not think the government set short term interest rates too low because I do not see the side effects such a policy would have caused.

There was a spike in commodity prices at the end of the bubble, just before the financial crisis. Oil, iron, copper, corn, and other prices were up. If the commodity prices had remained high, consumer prices would have risen by a similar amount six months to a year later. This spike occured at the end of the bubble, not at the beginning, so this is not the cause of the bubble. This means the government was printing too much money towards the end of the bubble, but not at the beginning of the bubble.

Just before, during, and after the financial crises, commodity prices fell. This means the government was not printing enough money, after previously printing too much money. The government was first too slow to respond to the inflation implicit in the commodity price spike, then deflated too hard in overcompensation, which exacerbated the financial crisis, and finally was too slow to start inflating again.

I do think that both long and short term interest rates were low, which contributed to a financial bubble, which contributed to the financial crisis. I think interest rates were low because the governments of various other nations lent a lot of money to America in order to devalue their own currencies in order to increase the profitability of domestic companies which competed with american companies, and especially to enrich the people who owned and managed these companies. I think these governments were stupid and corrupt to do this; these governments should have spent the money on services or tax cuts for their people. I think the american government did nothing to neutralize these capital inflows into America, and I think doing nothing was the right thing to do. So I do not blame the american government for this.

The financial crisis of 2008 shows the fundamental defect of capitalism. That defect is government. Most businesspeople are honest and law abiding. When the government commands businesspeople to do stupid things that damage the economy, the businesspeople obey.

The government chose to bail out some businesses like Bear Stearns, AIG, and Fannie Mae. The government chose not to bail out other businesses like Lehman Brothers. Usually when the government favors some businesses over others, the government favors the businesses which lobby the government the most. Firms which lobby the government for subsidies are usually less honest than businesses which do not lobby the government. So the government is preserving the dishonest businesses and allowing the honest businesses to fail.

If the government continues to encourage businesspeople to be dishonest, the next generation of businesspeople will probably be less honest than the current generation, and eventually the government may succeed in creating a business class so dishonest that they ignore government commands to damage the economy.

An economic system based on unregulated capitalism would have many problems, but an economic system based on bad regulation of capitalism is worse. The government does not seem capable of making good regulations, so deregulation is the least bad of the possible solutions.

Many people have described the 2008 financial crisis by saying that the financial plumbing is stopped up. I think this is a poor analogy. There are some people who borrow money and some people who save money. There are also some businesses which borrow money and some businesses which save money. Insurance companies and pension funds are especially likely to save money. Banks are financial middlemen. Banks borrow from businesses and people who save money, and lend to businesses and people who borrow money. Savers and borrowers can save money by eliminating the middlemen. For example, instead of you borrowing from a bank, while your neighbor deposits money in the bank, you could borrow directly from your neighbor; and you will pay a lower interest rate than you would pay to the bank, while your neighbor receives a higher interest rate than the bank would pay. But most people and businesses prefer to pay extra to use financial middlemen, because financial middlemen provide diversity and liquidity, and because it is easier to use financial middlemen. If the financial plumbing was stopped up, there would be two effects: it would become more difficult for people and businesses to borrow money, and it would become more difficult for people and businesses to save money. I have heard many stories about people and businesses having difficulty borrowing money, but I have not heard a single story about people or businesses having difficulty saving money. I have not heard of a single bank which has stopped paying interest on deposits to discourage people from depositing money. I have not heard of a single mutual fund which has raised fees to discourage people from investing. Banks accept deposits so banks can lend the money to other people. If banks really stopped lending money, then there would be no reason for banks to accept deposits; thus a bank which stopped lending money would stop accepting deposits. But banks are still accepting deposits. Therefor the financial plumbing is not stopped up. Financial flows have not stopped, but have been redirected. But redirected to where? Maybe to real estate in Dubai? I wish a financial newspaper or magazine would research this. We cannot understand the financial crisis unless we understand where the money has been redirected to.

Before the financial crisis, it was easy for banks, hedge funds, and other financial businesses to borrow money at low interest rates and invest the money at a higher interest rate. I thought this was a bad deal for the lenders. The lenders received a low interest rate, but if the investments lost money, the financial companies would default and pass the losses on to the lenders. So the financial companies kept the profits, while the lenders kept the risks. I thought the lenders were stupid. I wish that a financial newspaper or magazine would research these stupid lenders, and tell us who they were and what they were thinking. Maybe they were foreign central banks trying to devalue their currencies to increase the profits of their export industries. Maybe they were regulated insurance companies commanded by stupid government regulators to make stupid investments. The regulators may have forbidden banks and insurance companies to gamble, but may have allowed banks and insurance companies to lend to gamblers. The existance of so much stupid investment resulted in big profits in the financial industry, which resulted in an expansion of the financial industry. I suspect that one cause of the financial crisis is that the stupid investors stopped being so stupid. If so, the financial crisis is a good thing because it is shrinking the bloated financial industry, and everyone outside the financial industry will benefit because the profits which the financial industry used to skim off the economy will be resistributed to everyone else.

Suppose the government attempts to stabilize the banking system by regulating banks so that banks cannot make risky investments. How does the government know which investments are risky and which investments are not risky? The government will have to convene a committee of experts to evaluate all possible investments and decide which investments are risky and which investments are not risky. So if the experts decide that an investment is safe, many banks will buy that investment, which will cause the price of that investment to rise. If the experts later decide that the investment is no longer safe, all banks will be required to sell that investment, which will cause the price of that investment to crash. When the government approves an investment, that investment will go way, way up because everyone will buy it at once. When the government declares that an investment is too risky, that investment will go way, way down because everyone will sell at once. The result is that the financial markets will become less stable. There will be more bubbles and more crashes.

In an unregulated financial market, investors frequently disagree about whether a stock is a buy or a sell. When one investor is buying, another investor is probably selling. As long as different investors are doing different things at different times, prices are stable. Bubbles and crashes occur when all investors try to buy or sell at the same time.

So if we want to stablize the financial markets, we must discourage investors from all doing the same thing at the same time. But government regulations require investors to do the same thing at the same time.

Before the financial crisis, most experts believed that Bear Stearns, Lehman Brothers, AIG, and Fannie Mae were not risky. So how could the government have seen the risk when most experts did not see the risk?

If the government attempts to regulate risk, it will be illegal for investors to question the conventional wisdom. It will be illegal to be a contrarian investor.

Investors who think the conventional wisdom is wrong stabilize financial markets. Financial markets are most stable when investors are doing wild and crazy things which are different from the wild and crazy things being done by everyone else. Financial markets are least stable when everyone is doing the same wild and crazy things.

For example, The Banker Who Said No; by Bernard Condon and Nathan Vardi; Forbes magazine; April 27, 2009; pages 94-100; says that D. Andrew Beal and Beal Bank refused to participate in the bubble, and were attacked by the regulators for doing the right thing. During the height of the bubble, instead of trying the to make the insane banks more sane, the regulators were trying to make the sane banks more insane.

Laws are more effective when the government is trying to suppress some fringe activity which only a minority of people do. For example, laws against murder are partly effective because only a minority of people are murderers. But laws protecting racial minorities from discrimination by the racial majority are usually ineffective. Problems in the financial markets are not caused by a few people doing stupid things. Problems occur in the financial markets when the majority of investors are doing stupid things. But investors do not knowingly invest stupidly. Investors who follow stupid strategies think the strategies are smart. The government could prohibit a minority of investors from following a nonconformist investment strategy. But the government should not do this because a minority of investors does not threaten the financial markets, and a diversity of investment strategies is good for the financial markets. And the government cannot prohibit an investment strategy which is followed by a majority of investors. How can an elected government prohibit something which a majority of people think is a good idea?

In a free market, businesses try to increase profits. Businesses could raise prices, but they will probably lose market share to competitors if they raise prices. They could reduce costs. Or they could gain market share, which requires reducing prices or increasing quality. So managers of free market businesses focus their attention on reducing costs and increasing quality. Regulated businesses also try to increase profits, but regulations limit what the business managers can do. So managers of regulated businesses focus their attention on evading the regulations.

Many people think the financial crisis of 2008 was caused by deregulation. I think this is wrong. I think the financial crisis of 2008 was caused by overregulation. There is a simple way to test this. Were the managers of the banks which failed acting like managers of unregulated businesses? Were they trying to reduce costs and increase quality? Or were they acting like managers of regulated businesses? Were they trying to evade regulations?

The financial crisis was partly caused by complex securities which few people understood. Why were so many of such complex securities created, and why did anyone buy them? Because complex securites are a way to evade regulations. The fact that banks were trying to evade regulations proves that banks were highly regulated, so deregulation could not have been the cause of the financial crisis.

The economic crisis was caused by bad regulation, not by deregulation.

I think that it is possible for government regulation to make the economy more stable and more prosperous. However, history shows that most attempts by governments to regulate the economy have produced bad regulations which made the economy less stable and less prosperous. If there had been no government regulation of the economy, the economic crisis of 2008 would not have happened. On the other hand, if there had been no government regulation of the economy, there would have been other economic problems, which would have been equally bad. So the regulated economy is just as bad as the unregulated economy. Economic regulation has accomplished nothing. The government spends vast sums of money regulating the economy. Businesses spend vaster sums complying with government regulations. If we abolished most economic regulations, the economy would still be just as bad, but we would be better off because all that money wasted on regulation could be used for roads, education, health care, tax cuts, higher wages, and lower prices.

After the bankruptcies of Tyco, Worldcom, and Enron; the government passed the Sarbanes-Oxley act to increase the regulation of businesses to prevent businesses from hiding risks and liabilities. Yet the 2008 financial crisis was caused by hidden risks and liabilities. The Sarbanes-Oxley act was supposed to prevent financial crises but it didn't work. The government's response to the 2008 financial crisis will probably be equally ineffective and wasteful.

See Anatomy of a trainwreck: Causes of the mortgage meltdown; by Stan J. Liebowitz; a chapter in the book Housing America: Building Out Of a Crisis; edited by Benjamin Powell and Randall Holcomb; Transaction Publishers; 2009.

See Too Big to Succeed; by Less Antman; The Freeman magazine; April 2009; pages 21 to 25.