I came across this editorial in the WaPo . Regardless of your political persuasion, the editorial makes an honest point. It's not a biased point, not a political point and not an ideological point. It's the unsexy truth that shouldn't get in the way of how we choose to view the financial matters that have dominated headlines in recent weeks.

What is disheartening is for people to know the premise of this article, process it and then continue along as if it doesn't count or matter in the formation of a correct opinion. That opinion doesn't necessarily have to be in agreement with mine but it should at least acknowledge the truth in some of the points in this WaPo article.

the problem with the U.S. economy, more than lack of regulation, has been government's failure to control systemic risks that government itself helped to create. We are not witnessing a crisis of the free market but a crisis of distorted markets.

Now, I don't consider that an opinion. It is true. If someone wishes to dwell on the regulation side of the argument, the simple premise just stated should figure into it. Are we regulating the free market or are we regulating against distortions and risks that can arise from regulation against a more basic flaw that would result from a pristine free market? The editorial admits that while the Bush Administration generally stood for light regulation of capital markets in the abstract, it didn't invent the approach. The deregulation in question happened in the 1990s under Clinton. But the deregulation wasn't by itself a problem...and this is part of the point. The deregulation to remove restraints on innovation and remove the wall between commercial and investment banking was fine so long as other regulatory factors and subsidies didn't distort market forces and goods that would cause problems. Allowing this freedom to the financial industry is good. Allowing this freedom to the financial industry while pushing laws, breaks and subsidies and regulations that pervert the goods the industry deals with is dangerous. There's a clear distinction there and the problem is the latter and NOT the former. The editorial rightfully notes the role of extremely influential non-free-ish market force-markers in totally changing the game at its foundations...like Fannie and Freddie, interest rate deductions, tax-write-offs on real estate and Greenspan's interest rate policies.

Unregulated derivatives known as credit-default swaps did accentuate the boom in mortgage-based investments, by allowing investors to transfer risk rather than setting aside cash reserves. But government helped make mortgages a purportedly sure thing in the first place. Home prices seemed to stand on a solid floor built by Washington.

Yes indeed. These "unregulated" derivatives were not operating with goods produced in a free market...or anything even CLOSELY resembling one. *A somewhat free market in highly dubious, tainted, regulated and distorted goods is NOT a free market (or anything even close). Please realize, this is not some purist technicality to absolve the idea of free markets from any blame. It is a devastatingly huge factor that rocks the very foundation of this entire issue. The editorial then makes the argument for how regulation should be used if at all and when it makes sense to use it:

when government favors a particular economic activity, however validly, it must seek countervailing control to ensure the sustainable use of public resources. This is why banks must meet capital requirements in return for federal deposit insurance. Congress did not apply this sound principle to Fannie Mae and Freddie Mac; they were allowed to engage in profitable but increasingly risky activities with an implicit government guarantee.

That FDIC example is perfect example. You can't have federal insurance without requirements for that insurance. Heck, even private insurance makes demands of its insured clients and these things affect rates and coverage. If we're going to have federally-guaranteed deposit insurance (a market-distorting government creation with implicit dangers on market behavior), it makes sense to have capital requirements to countervail the potential systemic risks from its very creation. To do one without the other is dangerous. The argument over whether we should even have an FDIC is another matter. I personally don't have a problem with because it helps engender confidence from depositors to avoid wide-spread panic and bank-runs. Is there another more free-market to handle it? I'm sure there is. And that discussion could be had another day but it's not the key matter here. The key matter is that government interference in the market needs regulation of the aspect of that market that can be perverted and cause a dangerous outcome....or....the interference is simply forgone in the first place. In the case at hand, I do not find the interferences to induce the sale and construction of homes than a freer market would allow to be a wise market-distortion worthy of the risks. It simply invited too many potential hazards. So we have to basic choices: Either the markets are left basically free to produce free market goods and to self regulate in a free market fashion with enforcement of existing laws against fraud and theft OR we apply smart regulation to guard against dangers produced by non-free-market laws, institutions, tax codes, monetary policy and so on that can undermine an otherwise freer system.

Government-sponsored, upside-only capitalism is the kind that's in crisis today, and we say: Good riddance.