A public good is something that the free market tends not to provide on its own, to the detriment of society. Pollution laws and police departments are classic examples. In the case of finance — and of the crisis of the past two years — this missing good has been strong regulation. A weak system of regulation allowed Wall Street firms to take on enormous debt. Those debts let the firms make more and riskier investments than they otherwise could have, lifting their profits. But when the value of the investments began falling, the firms had little margin for error. They were like home buyers who made a tiny down payment and soon found themselves underwater.
It was tempting to let the banks fail. They certainly deserved it. But big bank failures often cause terrible damage. Credit dries up, and the economy can enter a vicious cycle of falling asset prices and job losses. That is what began to happen in 2008. To get credit flowing again, the federal government came to the rescue with billions of taxpayer dollars. It was a maddening story line: the government helped the banks get rich by looking the other way during good times and saved them from collapse during bad times. Just as an oil company can profit from pollution, Wall Street profited from weak regulation, at the expense of society.
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