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Jewish World Review
June 24, 2009 / 2 Tamuz 5769
The nirvana fallacy
President Obama has announced his
"sweeping overhaul of the financial regulatory system."
We can debate endlessly whether the Constitution authorizes any
president to "overhaul" the financial system. But I want to focus on a
different matter: whether any president, with all his advisers, is capable of overseeing something as complex as the financial
My answer is no, and it is ominous that a bright guy like Obama
doesn't know this. He thinks he must regulate the system because
it is so complicated and important. In fact, those are the
reasons why he cannot regulate it, and should not try.
As F.A. Hayek said in accepting the 1974 Nobel Prize in
economics, "[W]ith essentially complex phenomena, the aspects of the events
to be accounted for about which we can get quantitative data are necessarily
limited and may not include the important ones." So when regulators set out
to redesign an economy, they display not wisdom but a "pretence of
Yet Obama is so confident.
"[W]e will … coordinate and share information, to
identify gaps in regulation, … solve problems in oversight before they can become crises … that will
allow us to protect the economy ." (Emphasis added.)
What Obama cannot tell us is why these are anything more than
words. We've heard them before. Why should we be comforted?
Regulators are human beings with the same shortcomings as
everyone else. Even if we assume they have the best motives, on what basis
do we believe they could possibly know what they need to know to manage a
financial industry that is complex beyond conception and changing every
day in response to new conditions?
Obama speaks as though these facts don't exist. He goes so far
as to say, "[W]e're proposing a set of reforms to require regulators to look
… for the first time at the stability of the financial system as a whole ." (Emphasis added.)
That is precisely what no one can do. The financial system isn't
a machine. It's people a huge number of them engaging in countless
transactions often on the basis of hunches that are not quantitative and
never written down. How is a regulator to keep tabs on much less
It cannot be done. If he tries, he'll end up stifling
competition, innovation and life-enhancing economic growth.
Contrary to the foes of free markets, the choice is not between
regulated and unregulated markets. As the French economist Frederic Bastiat
long ago pointed out, the free market is
regulated by its own logic. If we have simple, easily understood rules
against fraud, then people acting in their self-interest, without privileges
or bailouts, generate market forces that create order and make our lives
better. The key is market discipline, which government reduces whenever it
Is the market perfect? Of course not. The market is people. But
the same kind of people will run the regulatory bureaucracy except they
play with other people's money and have brute power in their hands. Here is
where Obama's planners commit what economist Harold Demsetz calls "the
Nirvana fallacy". They compare the real-world
marketplace to an idealized regulatory apparatus run by omniscient
But the latter is not available, so the comparison is pointless.
We must choose between two systems, both run by fallible people. The
decentralized, competitive market full of free people is hands-down
preferable to a centralized body of clueless bureaucrats who can hold a gun
to our heads.
Obama says the free market is "not a free license to ignore the
consequences of our actions." He's right but doesn't understand why. A
genuine free market allows risk takers to fail and suffer "the
consequences." Only government can grant "license" to ignore consequences.
Government caused the financial morass by doing just that pushing banks
to weaken mortgage lending standards, pressuring Freddie and Fannie to buy
up dodgy mortgages and sell them as safe securities, bailing out big banks
when they got into trouble and insuring bank deposits thereby encouraging
us not to care if banks are reckless.
Government failed, not the market. Obama's answer? Just like
George W. Bush's: more government.
Give me a break.
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