So here we all sit in a major financial crisis (at least that is what we are told) and the middle of a presidential election. What could be more fun! I have listened intently to the debate and solutions from all sides and wonder how we could be missing a couple of key assumptions that got us into this mess in the first place. Both political parties are a disaster on this issue and neither should be spared the wrath of main street. There is plenty of blame to go around and Wall Street, Democrats, Republicans, and the White House need to fess up to their portion and quit blaming everyone else. There are two core assumptions that have proven to be false, with each political party driving separate assumptions. Ironically, this has been turned into an issue of the failure of capitalism, when in reality it is a failure of big government socialism that has been demonstrated.

The mistake the Democratic Party made was to force public policy to be more important than accounting for risk in the private credit markets. Risk is an important governance system. Risk makes sure that the right decisions get made and some amount of balance is in the system. Some people are high risk when it comes to credit and for a while it was difficult for them to get credit for houses and education. For over a decade the Democratic Party has been driving the need for home ownership and access to credit for everyone. This is a great public policy debate and I do not disagree with that goal. The problem, however, is that the execution of the public policy went through the private credit markets and eventually led to banks being more concerned about meeting the political demands for more access to credit, then the financial risk of make loans to high risk people. When there was not enough funds allocated through government programs to perform the job, they (democrats) pressured the mortgage lenders to provide loans. Regulatory oversight did not work because Democrats in Congress did not want it to work. Regulatory oversight would have shut off access to credit for millions of people. Capitalism only works when financial risk and public policy are kept separate. Socialism combines financial risk and public policy into the same decision making process, which will always fail. If you socialize the risk there is no motivation for sound lending practices (or any sound behavior), as we have discovered.

The mistake the Republican Party made was to allow banks to merge and get larger and larger to improve their bottom line and allow them to be more competitive. Eventually, this drove many institutions to be so large they were too big to fail, thus driving the bailout. Capitalism will never work if organizations are allowed to be so big that they cannot fail, in fact at that point it is a socialist system. Frankly, if an organization becomes too big to fail it is by definition a government entity and may as well be treated as such.

The recent failure in the financial markets is not a failure of capitalism, it is a failure of big business/big government socialism. There is no meaningful difference between big business and big government (I would be happy to explain this in a future editorial) and if we want to avoid this problem again in the future we must take two steps. The first is to always make sure that risk and public policy are separate. If government wants to provide credit access to homes, education, etc. to everyone, then it should come through the government, not through private lenders. Second, no financial institution should be allowed to become so large that they cannot fail. Those banks that are large should be broken up into smaller companies. We can continue to believe that big government/big business is the best solution and pursue the bailout and other current policies (which is the current direction of both political parties), or we can finally admit that local government/local business is the best solution to dealing with social and economic issues.