The Free Market: A False Idol After All?

FOR more than a quarter-century, the dominant idea guiding economic policy in the United States and much of the globe has been that the market is unfailingly wise. So wise that the proper role for government is to steer clear and not mess with the gusher of wealth that will flow, trickling down to the every level of society, if only the market is left to do its magic.

That notion has carried the day as industries have been unshackled from regulation, and as taxes have been rolled back, along with the oversight powers of government. Faith in markets has held sway as insurance companies have fended off calls for more government-financed health care, and as banks have engineered webs of finance that have turned houses from mere abodes into assets traded like dot-com stocks.

But lately, a striking unease with market forces has entered the conversation. The world confronts problems of staggering complexity and consequence, from a shortage of credit following the mortgage meltdown, to the threat of global warming. Regulation — nasty talk in some quarters, synonymous with pointy-headed bureaucrats choking the market — is suddenly being demanded from unexpected places.

The Bush administration and the Federal Reserve have in recent weeks put aside laissez-faire rhetoric to wade into real estate, wielding new rules and deals they say are necessary to protect Americans from predatory bankers — the same bankers who, only a year ago, were being lauded for creativity. Were the market left to its own devices, millions could lose their homes, the administration now says.

Central banks on both sides of the Atlantic are coordinating campaigns to flush cash through the global economy, lest frightened lenders hoard capital and suffocate growth. In Bali this month, world leaders gathered in the name of striking agreement to slow climate change.

Adam Smith used the metaphor of the invisible hand to describe how markets should function: With everyone at liberty to pursue self-interest, the market omnisciently distributes goods and capital to maximize the benefits for all. Since the Reagan administration, that idea has weighed in as a veritable holy commandment, with the economist Milton Friedman cast as Moses.

As the cold war ended and Communism retreated, the invisible hand seemed to monopolize economic thinking. Even China, controlled by a nominally Communist party, has blessed private entrepreneurs and foreign investment. In Latin America, the International Monetary Fund financed governments that embraced market forces while shunning those that were resistant.

But now the invisible hand is being asked to account for what it has wrought. In this country, many economic complaints — from the widening gap between rich and poor to the expense of higher education — are being dusted for its fingerprints.

After two decades of disappointing economic growth, several Latin American countries have spurned the I.M.F. while embracing the finance and thinking of Venezuela’s avowedly Socialist leader, Hugo Chávez. China’s leaders, though still devoted to “reform and opening,” are keeping tight control on the value of the currency while steering capital to powerful state-owned companies, concerned that freer markets could throw millions of peasants out of work.

Throughout history, regulation has tended to gain favor on the heels of free enterprise run amok. The monopolistic excesses of the Robber Barons led to antitrust laws. Not by accident did strict new accounting rules follow the unmasking of fraud at Enron and WorldCom. Now, the subprime fiasco and a still unfolding wave of home foreclosures are prompting many to call for new rules.

“We’re revisiting the question of market flows with a deservedly wary eye,” said Jared Bernstein, senior economist at the liberal Economic Policy Institute in Washington. “For decades, economists and political elites have argued that any time you regulate any aspect of the economy, you’re slipping the handcuffs on the invisible hand. That’s demonstrably wrong in lots of ways.”

But if markets can inflict pain, the harm from trying to tame them is often worse, argue those who would let the invisible hand carry on. The new regulatory tilt threatens to tie up innovation in a straitjacket of bureaucratic nannying while slowing the global economy, they say.

“Every regulation reduces people’s freedom,” said David R. Henderson, a libertarian economist at Stanford University’s Hoover Institution. “The more regulation we get, the worse we do.”

Mr. Henderson is critical of the Bush administration’s effort to freeze mortgage rates, and the new rules proposed by the Fed intended to curb nefarious lending. They undermine the sanctity of contracts, he said, while making mortgages harder to gain for everyone.

“The way they justify it is that you’ve got to protect the stupid people who can’t read a contract,” Mr. Henderson said. “But they’re treating everyone as stupid.”

But in Washington, and under the roofs of many homes now worth less than a year ago, there appears to be a shift in the nation’s often-ambivalent attitude about regulation.

Back in the boom, banks made loans to homeowners who did not have to prove their ability to pay, then quickly sold the loans to other companies. By the time it emerged that a lot of homeowners could not pay, these loans had been pooled with other loans and chopped into strange new paper assets that were sold to unsuspecting buyers around the globe. The subsequent reckoning has forced major banks to write off vast sums of money.

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