Government should neither discourage or encourage risk taking

Peter Robinson has an excellent post on supply side economics over at Ricochet. But he does include this statement which I take some issue with:

The government ought to encourage individuals to form enterprises, take risks, and invest.

One one hand, I understand what he is saying. The government is too often in the business of discouraging investment, work and risk taking. On the other hand, the idea that the government should be encouraging risk taking is problematic.

After all, the politician's favorite way to encourage risk taking is by putting taxpayers on the hook for losses. Whether these policies are explicit, (i.e. loan guarantee programs, deposit insurance, or other subsidies), or implicit (i.e. government sponsored enterprises such as Fannie and Freddie, the Federal Reserve's habit of flooding the banking system with liquidity every time Wall Street gets into trouble, or the broader notion of "too big to fail"), these policies distort the process by which the market prices risk. This leads to mal-investment, speculative bubbles, and ultimately, taxpayer bailouts. Exhibit A is the housing and financial crisis, as explained by Russ Roberts in his white paper entitled "Gambling with Other People's Money".

The amount of risk that should be financed in our economy is ultimately something that should get settled in the capital markets through millions upon millions of negotiated transactions between those who need capital (business enterprises) and those who provide capital (investors). The idea that politicians and bureaucrats are capable of shaping, molding and fine tuning the capital markets without doing harm is the kind of thinking that will lead to the next financial crisis.

Is Peter Robinson arguing for subsidies and loan guarantees and too big to fail? Not at all. My point is that if we are ever going to win the historical argument over what caused the financial crisis, I think we should get the language right.