Department of Government Making the Problem Worse

Shankar Vedantam in today's Washington Post tells us something that Conservatives believe and Liberals refuse to admit.

Trying to fix problems that affect vast numbers of people has an intuitive appeal that politicians and policymakers find irresistible, but several warehouses of research studies show that intuition is often a poor guide to fixing systemic problems. While it seems like common sense to pump money into an economy that is pulling the bedcovers over its head, the problem with most social interventions is that they target not robots and machines but human beings -- who regularly respond to interventions in contrarian, paradoxical and unpredictable ways.

"How well does government do in helping the market to improve what it does?" asked Clifford Winston, an economist at the Brookings Institution and the author of the 2006 book "Market Failure Versus Government Failure." "The research consistently finds that, in fact, government efforts to correct market failures have little effect, or actually make things worse."

In many cases, government intervention creates what is known as "moral hazard." As an example, FDIC insurance on savings accounts allows people to ignore the risks associated with banks that make risky loans. that means that the "risky" banks can pay higher interest rates on their deposits, attracting more money, because if they fail the government will bail out the depositors. Thus, the FDIC encourages banks to take more risk than they would if their deposits were not insured.

The same applies to the ultra-large banks that are deemed "too big to fail." If a Citigroup or Bank of America were allowed to fail, the effects on the economy would be severe, although temporary. To avoid the short term pain, the government intervenes and props up banks that are - by most accounting standards - bankrupt. And don't think for a moment that the people who run those banks don't know that.