This is the fifth installment of “Providing Relief from the Crisis.” Read editor-in-chief R. Emmett Tyrrell, Jr.’s introduction here.

The current financial crisis has led to unprecedented peacetime government intervention in the national economy. Approximately $8 trillion of government purchases of equity in financial institutions, loan guarantees, and other credit has flowed from various federal agencies in a matter of weeks. Those who agree with Hayek that government agents are unable to collect and process the information that is necessary to direct a modern dynamic economy, will wonder at the speed with which we have moved towards what Ludwig von Mises called “planned chaos,” and Hayek called “the road to serfdom.”

Regardless of issues, such as the risk to taxpayers, the real concern should be that we are expanding government in a way that Robert Higgs warned about in his 1987 book, Crisis and Leviathan, while ignoring a simpler noninterventionist approach.

There has been a good deal of literature on the cyclical effects of regulatory capital requirements, and in particular, mark-to-market accounting. In a 2004 paper, University of Chicago and Harvard University professors Anil Kashyap and Jeremy Stein concluded that enforcing exactly the same capital requirements during the upside and downside of business cycles has the potential to add significantly to cyclical behavior and results in inefficient credit markets. An implication of their research is that capital requirements should be lower in a downturn when the cost of capital is high.

In the current credit crunch, mark-to-market accounting has exacerbated the already pro-cyclical effects of capital requirements. Wachovia having to sell its mortgage-based securities at fire sale prices caused other financial institutions to mark the value of similar assets down, requiring them to raise capital, reduce their loans, or both.

As mortgage-based securities decline in value no financial institution wants to hold them, the market becomes illiquid, and the sales that do occur are under distress, further reducing bank capital. Rather than reducing capital requirements in a downturn, as suggested by Kashyap and Stein, mark-to-market accounting has the effect of increasing capital requirements, leading to further contraction of credit, a scramble for capital, and declining economic activity.

Rather than the government buying banks and other financial institutions, and lending trillions of dollars to whichever firm shows up with the best lobbyist, a simple solution is to allow financial institutions to account for their assets in a fashion that allows for a value closer to the true value of the underlying asset and yet is transparent, so investors and depositors may make a rational choice as to whether to invest in or make a deposit in the institution. Individuals acting according to their own plan and taking responsibility for their actions will outperform regulation. While there may be costs to eliminating mark to market capital requirements, the alternative of massive government intervention will be much greater in the long term.