Tom Woods (author of Meltdown) has an excellent article up at lewrockwell.com which succinctly demonstrates why it is not the free market that is to blame for the crisis but rather the government and central bank - the very institutions that are being hailed as our saviours. It is my view that the 'fool's paradise' that is Australia will be exposed for what it is at some point this year and this article explains in part why (in particular read the part about Greenspan and the 2001 U.S. recession). Here is Woods's summary of Hayek's point on why we have boom-bust cycles:
Scenario 1 [housing expansion on a free market]. Consider what happens when the public increases its savings. Since banks now have more funds to lend (namely, the saved funds deposited by the public), the rate of interest it charges on loans will fall. The lower interest rates, in turn, stimulate an expansion in long-term investment projects, which are more sensitive to interest rates than short-term projects are. (Think of the difference in the decline in monthly payments that would occur between a 30-year mortgage and a 1-year mortgage if interest rates came down by even 2 percentage points.)
Lower-order stages of production are those stages closest to finished consumer goods: retail stores, services, and the like. Wholesale and marketing are examples of higher-order stages. Mining, construction, and research and development are of still higher order, since they are so remote from the finished good that reaches the consumer. When people’s consumption spending contracts, it is a perfect time for higher-order stages of production to expand: because of people’s additional saving, there is relatively less demand for consumer goods, and the resulting contraction of lower-order stages of production will release resources for use in the higher-order stages.
Scenario 2 [housing expansion with artificially manipulated fiat currency]. Government-established central banks have various means at their disposal to force interest rates lower even without any corresponding increase in saving by the public. Just as in the case in which public saving has increased, the lower interest rates spur expansion in higher-order stages of production.
The difference, though, is a critical one and guarantees that these artificially low interest rates will not yield the happy outcome we saw in Scenario 1. For in this case, people have not decreased their consumption spending. If anything, the low interest rates encourage further consumption. If consumption spending is not constricted, the lower-order stages of production do not contract. And if they do not contract, they do not release resources for use in the higher-order stages of production. Instead of harmonious economic development, there will instead ensue a tug of war for those resources between the higher and lower stages. In the process of this tug of war, the prices of those resources (labor, trucking services, et cetera) will be bid up, thereby threatening the profitability of higher-order projects that were begun without the expectation of this increase in costs.
As the workers in the newly expanded higher-order stages of production begin to spend their incomes, they spend according to the same saving-to-consumption ratio they did in the past. Their desire to save, and thereby to sustain all this long-term investment, turns out to be not as great as the distorted structure of interest rates led entrepreneurs to believe. It becomes ever clearer that society is not prepared to support the expansion of time-consuming higher-order stages of production. They do not wish to save enough resources to make the completion of all the new projects possible. The lower-order stages will win the tug of war. Expansion in the higher-order stages will have to be abandoned. Some of the resources deployed there will be salvageable; others will have been squandered forever or will be of little to no use in later stages of production.
I suggest reading the whole article - there is a great quote near the end on why regulation cannot fix banking from Guido Hülsmann's The Ethics of Money Production.
