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The government regulates some of the behavior of financial markets. Understandably, especially considering the crisis.

But would it not be easier if the government overtook some of the aspects of the financial markets? In that case, regulation would not be necessary, since the government was in charge of that particular aspect.

For example, say the government overtook the business of giving out mortgages to house buyers. In this case, the government would not have to worry about banks giving out subprime mortgages, securitizing them, and selling them off, the government would be in charge of the entire process and since the government does not seek profit-maximization, it would make sure to do it right.

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    $\begingroup$ Because public firms have other problems. Most industries are regulated somehow. By your logic, why not put almost all companies into the hand of the government? $\endgroup$
    – BB King
    Commented Mar 14, 2018 at 19:07
  • $\begingroup$ Governments do intervene in “financial markets.” In Canada a government agency acts to guarantee “subprime” mortgages, and governments have student loan programmes. (The United States government has large involvement in student loans.) The US 30-year fixed mortgage only exists because of government (or quasi government) agencies. $\endgroup$ Commented Mar 14, 2018 at 19:44

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Governments do offer financial services. It varies from country to country, and changes over time. The political drift has been to reduce the role of government since the 1980s, so this role has generally shrunken.

For example, some countries had postal banking - citizens had basic banking functions offered at post offices.

I will just use some Canadian examples; other countries have similar programmes.

The Canadian government has a Business Development Bank, which helps new firms develop (website). It is taking on risks that commercial banks would be reluctant to take.

The Canada Mortgage and Housing Corporation (CMHC - website) has a programme of mortgage insurance that is compulsory for all high loan-to-value mortgages in Canada (“subprime”). The loans have to meet minimum risk standards, but the loan guarantee means that the private banks are not exposed to the risk of the mortgages. The Canadian housing market slowed down during the Financial Crisis, but fared better than the United States. The fact that the Canadian banks were insulated from the credit risk of risky mortgages was certainly a factor.

Returning to your question - why not expand the programme, and have the government completely take over the mortgage lending role? One obvious advantage for the government is that it is not forced to justify lending decisions to citizens - that is being done in the private sector. People could easily be concerned about favouritism in lending decisions if the government controlled all mortgage lending. For example, if the child of a politician gets a big mortgage when other people are being refused, it could easily turn into a political scandal. On top of this, there is the ongoing political argument between government control versus free markets. The objective of this website is to avoid opinion-based answers, so I will not dwell on that political debate.

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  • $\begingroup$ Also, profit seekers are often believed to be better at innovation than public servants or companies owned by government. However, it can also be noted that some argumentation on the question goes out of its way to ignore or divert from issues such as rent seeking (related to the interest of profit seekers to try to influence government to tilt things in their favour regardless of whether it is beneficial to the economy as a whole). $\endgroup$
    – nathanwww
    Commented Mar 15, 2018 at 2:38
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regulation would not be necessary

The regulation would still be necessary: a government service would need to regulate itself.

the government would not have to worry about banks giving out subprime mortgages

Again, yes it would. It would need to have methods to analyze mortagage opportunitites and avoid "subprime" ones - which isn't cut and dry.

since the government does not seek profit-maximization, it would make sure to do it right.

This is a pretty big misconception. The lack of a profit-maximization motive actually makes it harder to do the right thing. What are they optimizing for if not for profit? Government offices often optimize for gaining budget and size. This might mean they give out more loans than private banks do. Or it might mean they give out too few loans when substantially more would be optimal. Or maybe they just become really bad at determinig which loans are worth giving. Since there's no direct incentive mechanism, its much easier for a government service to drift away from efficiency. This is a primary problem with nationalized services.

Fundamentally, the role of government is not simply to solve big problems. There are many things that the market is known to be far better at solving than governments. The converse is not true - there are not many things that it can be shown a government is better at doing. However, there are things it is known that the market is not as good at solving. Those things are often called "market failures". The only possible things that its economically appropriate for a government to do are dealing with market failures, provided that the government solution has lower costs than the market solution.

Just like there are market failure, there are also government failures, and it is generally not clear which is worse.

The 3 types of market failures are:

  1. Externalities
  2. Anti-competitive markets
  3. Suboptimal initial resource allocation

Finacial services do not generally have any of these kinds of market failures going on (except the ones caused by government intervention) and so it would be inappropraite for the government to provide financial services of any kind.

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