As the financial crisis deepens, it is becoming clear that two assumptions economists like to make are completely wrong: people act rationally and the free market exists.

The crisis might not have been created by panic but it certainly has been worsened by it. It does not help that there are people suggesting selling most stocks. The word “panic” keeps creeping into headlines reflecting knee-jerk reaction from the sellers on Wall Street. Selling certain stocks might be a rational thing to do but, for the most part, selling in a drastic downturn like this is the stupidest thing one can do. You’re locking in your losses. If you’ve set up a portfolio that is diversified, just stop looking at its performance and ride this thing out. But few people seem to be able to do this; otherwise stock markets wouldn’t keep going down.

One of the fundamental issues underlying this crisis is lack of information. The credit market froze because nobody knew what the other institution really owned and owed. Nobody trusted anybody, so institutions hankered down and stopped lending money. Information is the key ingredient to a free market, without it, nobody can evaluate other’s position objectively. Clearly, information was not (and is not) flowing freely. It only seems to flow if people are forced to give it up. That force ends a free market. Regulation is coming in that enforces the rules that a free market should automatically reinforce. Since that doesn’t happen, the idea of a free market should be shelved right next to the bible and other fairy tales.

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