Given the country’s current economic difficulties, the flurry of debate over how best to handle the problems faced by the financial sector is understandable. Americans are not only looking for a way to recover from recession, but also to avoid a resurgence of the risky lending practices on which many pin the blame for our economic woes. I propose that to do this, what we need is a return to good old-fashioned capitalist principles. Not surprisingly, the Fed disagrees.

In a New York Times Online article, the Times reports that the Fed is considering broad regulations on pay practices at US banks:

Fed officials will be scrutinizing whether the structure of compensation, like the use of bonuses based on the volume of loan origination, encourages excessive risk-taking.

Interesting. The last time I checked, we didn’t need the government to discourage “excessive risk-taking”. The free market does that. That’s how capitalism works. Companies that take irrational risks are punished with decline and failure- that is, when Congress doesn’t step in and bail them out. In short, what the banking system needs now is not more public control of its pay practices, but less public subsidy of its failures. If banks knew they would face real danger of bankruptcy should they make overly risky investments, they would have greater incentive to avoid such risks. If they gave in and took unsuccessful risks anyway, they would go out of business or decline in prominence, and new, more cautious banks would rise to the top of the market hierarchy.

Far from moving the financial sector in this direction, however, the Fed’s proposed restrictions are simply one more step in the direction of a nationalized banking system. Under its new rules, the Fed would even have the power to “evaluate each [bank's]  plan to see if the pay incentives properly balance goals of short-term sales and production against long-term risk-taking.” Once again, this is not the job of the government! It is a company’s job to evaluate the balance between short-term and long-term cost and benefit of a particular practice.

On an individual level, socializing such a job seems utterly ridiculous. For instance, I could study the weekend before finals, thus mitigating my long-term risks, or go to parties the weekend before finals, thus increasing my short-term enjoyment, but also increasing the longer-term risk of poor performance on my finals. Clearly, the choice between these two options is mine to make, and few people would argue that my peers should pay for a counselor to help me make my decision.

Further, if we wouldn’t, as a society, encourage such indulgence with regards to a conflicted college student, why should we advocate it when it comes to our banking system? It is not the duty of the public at large to pay the salary of a guide for banks that refuse to control themselves, nor is it fair to the banks to have their free will stripped. Finally, and perhaps most importantly, it is not fair to those that do control themselves for the government to assist their competition. So, rather than increasing government involvement in this area of US banking, we should instead put our trust in the capitalist system that has run our country for centuries.