Washington's response to the current financial trouble is affirming Groucho Marx's definition of "politics": "The art of looking for trouble, finding it everywhere, diagnosing it incorrectly, and applying the wrong remedies."

To be sure, we are in a financial mess.  Too many banks lent money to credit-risky consumers they shouldn't have lent money to, and too many consumers borrowed more money than they could afford to borrow.  But the remedies being proffered by our politicians will likely miss the mark, once again.

Why?  The very people who created our current problems think they can now solve it by doing more of the same.  Indeed, politicians who have consistently used the heavy hand of government in our economy are claiming that more government intervention and manipulation of the market is the solution.  They want us to believe that throwing more gasoline on a fire will put out the flames.

The reality that most in Washington, D.C. refuse to acknowledge is that our current financial woes are a direct result of the federal government's encouragement and financial backing of poor lending practices.  Through a variety of political decisions by both Democrats and Republicans – including loose monetary policy, the Community Revitalization Act which forced banks to loan to credit risks, and using Fannie Mae and Freddie Mac to encourage subprime loans – the fundamental cause of the current crisis has been government created.

It is equally important to recognize that our market economy is not to blame for this mess.  Many politicians, like House Speaker Nancy Pelosi, have erroneously focused their criticism on capitalism, claiming that the problem is the result of "no regulation, no supervision, no discipline."  Although such rhetoric may sell on the campaign trail, it denies the fact that the current trouble is occurring in one of the most heavily regulated and supervised sectors of the financial industry.  Indeed, Fannie Mae and Freddie Mac couldn't have been any more of a government regulated and supervised entity, yet it still collapsed.

But instead of allowing the banks who made bad decisions to fail and consumers who borrowed more than they could afford to take personal responsibility, politicians will further distort the economy.  It will be the fiscally prudent banks that will eventually be over-regulated and the credit-worthy consumers who will ultimately pay the price.

There is no pain-free choice.  The choice isn't about whether or not we will experience some financial tragedies, but whether or not we believe that the same government actors who significantly contributed to the problems we face today can actually come up with the solution.  Chances are they won't.

We must recognize that comparisons to the Great Depression are greatly exaggerated.  As Allan Reynolds of the Cato Institute points out, "we have had little more than a dozen bank failures this year compared with more than 5,000 in the 1930s, and nearly 3,000 in the 1980s."  Even more important is that the failure of those banks occurred after government "did something" – namely, increased taxes, increased tariffs, and created the Reconstruction Finance Corporation. 

The only appropriate analogy to the events before and after the October 1930 collapse is that President Bush, like President Hoover, plans to heavily intervene in the economy.  Bush, like Hoover, is criticized as having been a hands-off, market-oriented, do-nothing president.  But the historical record has shown that both presidents have been strong government interventionists rather than free market advocates.

Politicians have a horrible track record of being effective economic planners.  We shouldn't allow government to spread losses to the rest of the economy.

What, then, should government do?

The answer is to embrace free-market solutions and allow the market to ferret out the bad actors and the bad debt in the marketplace.  There are a number of proposals that would do this, including altering current accounting regulations such as "mark-to-market," lowering taxes on investments, and privatizing Fannie Mae and Freddie Mac.  These are a few policy changes where government can "do something" without doing damage.

Unfortunately, panicked politicians are running away from these solutions.  They are instead proving Groucho Marx was right by incorrectly diagnosing the problem and applying the wrong remedies.

Matthew J. Brouillette is president and CEO of the Commonwealth Foundation in Harrisburg, Pennsylvania.

October 3, 2008