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Words from Winterbilt

A brief history of free markets

Shannon Bohrer

(10/2012) Once upon a time, the United States experienced a financial collapse that started with a housing bubble that spread to mortgage crises. This was closely followed by problems in the financial markets when investors relied on complex financial instruments. Was the cause of this financial collapse a free market or a lack of a free market? Or was it excessive regulations? Or maybe just greed? I believe there are cases to be made on many different sides of this issue. But, no matter where you stand, there are numerous talking heads and politician-types that preach that the free market is the Holy Grail that will save us. According to these talking heads, free markets work better than government programs, free markets lower cost with competition, free markets are the fuel for a growing economy, free markets are good for our country, and free markets make us smarter! They do indeed make a good argument.

When the "experts" talk about free markets, they use Cornelius Vanderbilt (the Commodore) as an example of how free markets work and why they are so important. Vanderbilt started his business using a small sail boat to move passengers and freight. By the time he died in 1877, his empire included railroads, and was very large and very vast. He is credited with starting the large corporations that we have today. His story is very impressive in that he faced fierce competition from every business he was involved in. Even more impressive is the fact that he competed against other businesses that were supported by government subsidies. You heard right, even before the Civil War, our government supported private industries with subsides. Vanderbilt went head to head with the government subsidized companiesó and won.

Vanderbiltís businesses succeeded against all competitors and it was all done in a free market; a truly free market, as there were no regulations at the time. The general strategy was simple: Lower your rates and keep them low until youíre competitor goes bankrupt. It worked. There was one occasion when Vanderbiltís competitors lowered their railroad freight rates so low that money could only be lost. Vanderbilt then lowered his rates, believing he was competing for business. However, his competitors who had initially lowered their rates then shipped their freight on Vanderbiltís railroad.

With no national regulations, Vanderbilt and other industrialist-capitalists that followed him were either very successful, or went broke. While Vanderbilt is credited with creating one of the first large corporations in our country, the totally free market also created some very large corporate monopolies. The business strategy of undercutting your competitors and then buying the remains at a fire sale was very successful and continued until large monopolies dominated the business landscape. In response to this business strategy of the "Robber Barons" of the day, the Sherman Antitrust Act was enacted in 1890. The purpose of the Sherman Antitrust Act was a commitment to a free market economy. As was widely reported at that time, "monopolies do not encourage free trade, they restrict it."

This brings us back to where we started. Remember the housing bubble, mortgage problems, and complex financial instruments that all occurred when the country experienced the financial collapse? That all happened in 1873, and at that time Vanderbilt was already an elder statesman. The 1873, financial collapse was called "the great depression" and was referred to as such until the country really did suffer the real Great Depression starting in 1929. And, just in case anyone forgot, we also experienced the panic of 1893, the panic of 1896 and the panic of 1907, just a few of the other financial issues we experienced between 1873 and the real great depression. I wonder if they will rename the 2008 recessionÖ Never mind.

Anyway, I digress. Because of the 1929 recession, the Glass -Steagall Act was passed in 1933. This act created the Federal Deposit Insurance Corporation, which separated investment and commercial banking. A large part of the act was an emergency response by the government since nearly 5000 banks had failed. Sound familiar? With the FDIC, the federal government was now providing insurance for depositors, with insurance funds provided from the banks themselves. Of course, the act separated the investment and commercial banks, as the government did not wish to provide insurance for the gamblers (I mean investment banking). This worked very well for a long time.

Fast forward to 1999: the Financial Service Modernization Act (Gramm-Leach-Bliley Act) was passed and congress repealed the Glass-Steagall Act. This removed the regulations barring mergers with banks, securities and insurance companies. It worked well for 66 years, but I guess we needed more free markets. Then, in 2008 we experienced a financial collapse that started with a housing bubble that spread to mortgage crises. This was closely followed by problems in the financial markets when investors relied on complex financial instruments. Does this not sound familiar?

We deregulated the savings and loan companies, they gambled and went broke. We then deregulated the energy futures market (a.k.a. Enron) and they went broke. Then we deregulated the banks and investment firms, or allowed them to become hybrids, but it turned out that they were not very efficient. However, they did not all go broke. And that was because the major difference between 1873 and 2008 was our governmentís willingness to bail them out. If one believes in free markets, are they still free if they are bailed out? I do believe that we have witnessed a pattern. In my former profession, we would call this a clue. Of course, if youíre a large investment firm and you have the capability of becoming a bank, you do it. Then you can gamble, I mean invest, and our government becomes your insurance company.

If you want to predict the future, just take a look at history.

Read other articles by Shannon Bohrer