The Road to Socialism Runs Through Deregulation

Today's 85 billion government bailout of the giant insurer AIG means that the Bush administration now owns Fannie Mae, Freddie Mac, and the country's largest insurance company.

As liberal blogger Matthew Yglesias notes, it's almost like the Bush administration has achieved "socialism in our time."

But the financial mess also leaves American economic and political elites with a significant choice--economic regulation or socialism.

If the U. S. continues down the road of laissez-faire deregulation recommended by the Republicans and the right, we'll end up with a semi-socialist economy in which the government owns the financial sector. That's because the lure of high profits will continually lead investors to assume that high-risk strategies are "sure things." In the current crisis, everybody involved thought that sub-prime mortgages were a route to big profits even though it was always highly unlikely that homeowners would pay off the mortgages. As a result, banks, mortgage lending businesses, and financial companies invested heavily in the mortgages and then packaged them as securities and sold them to other companies.

AIG's was heavily invested in all aspects of the sub-prime morgage pyramid scam, and so far, it's cost AIG more than $100 billion and taxpayers are now on the hook for $85 billion of that.

Of course, a loyal free-marketer would just say to let AIG default. But smaller banks and money-market funds are heavily invested in AIG's financial instruments. As a result, an AIG failure would destroy a significant chunk of working capital and have heavy ripple effects through the economy. Consequently, the Fed concluded that AIG was too deeply integrated into the economy as a whole to allow to fail and decided to make an $85 billion bridge loan in exchange for 79% of the company.

In other words, the laissez-faire policies of the Republican Party are a prescription for socialism. Indeed, the Bush administration took 100% of Fannie Mae and Freddie Mac.

The other route is for the federal government to more actively regulate the financial sector in a way that's generally advocated by the Democrats. Stricter forms of regulation would discourage the development of extremely risky strategies like making sub-prime loans, bundling those loans into securities and seemingly flooding the market with those securities. Thus, they would function to stabilize the financial markets. Of courese, going the regulation route would suppress short-term financial sector profit and marginally lowering short-term economic growth as a whole. But the financial sector and the economy as a whole would be more stable in the long-run.

In this sense, Democratic approaches to regulation would preserve capitalism against the massive shifts toward government ownership that result from Republican policies.

Save American capitalism, vote for Barack Obama.