If someone else has already pointed this out, please let me know. I have yet to see anyone anywhere make this point.

A lot of people are claiming the current credit crisis as a failure of the free market system.

Now, whatever your stance on the capitalist system is — good, bad, flawed, or perfect, right now that doesn’t matter. This post is here to make one point: the global financial sector does not operate as a free market.

How so?

The banking system operates under the direct support of the government. The US Federal Reserve, just like every other central bank, controls interest rates. Not only does the interest rate act as a price control mechanism, the capital flows & liquidity that are provided to the banking system act as a government subsidy. Without this level of government intervention there would be no business model.

Additionally, there is no historical basis for the long term stability of banking. Again and again government agencies are required to bail out banks, dating back hundreds of years. Nassim Nicholas Taleb pointed this out in his very, very timely 2007 book, The Black Swan.

Why does the banking system continually fail? Leverage. When you have no leverage riding out difficult times is achievable. The model of fractional reserve banking mandates the use of leverage. What kind of profits would banks earn if they could only lend out $1 for every $1 of deposits?

As I’ve said elsewhere, I think we may be facing a full blown end to a credit super cycle. It may happen rapidly, or it may be stretched out over the course of 10 years. I don’t know. With low overhead and nearly unlimited flexibility I am very happy to be in the business I am in. You should be too.

There could be a pretty good explanation for this.

I have made a conscious attempt to avoid posting financial advice or predictions. I do not trade stocks or actively invest in any non-digital assets. For me the return online is far too great to be distracted elsewhere.

That being said, I feel that I owe some advice to those still reading this blog.

The details of what has happened will not be covered here. If you read the Wall Street Journal, watch CNBC, or read/watch Bloomberg you know whats going on. If not, your probably in the dark.

Nothing that has happened was unexpected, new, or shocking. Last year I tore an article out of Portfolio magazine in whichthe end of at least one of the major investment banks was predicted. I stuck it in the bottom of my sock drawer. Out of all of the books, newspapers, and magazines I had read, it just made too much sense. It turned out to be conservative.

Here is what matters for you, as a business owner –

You have to ride out the storm. There just is no other option. It might be short, it might be long. It might clean out some of your friends.

In tough times only cash and the lack of debt or other long term liabilities provide the buoyancy that will keep you afloat.

The collapse of the dot com bubble destroyed online businesses and billions in wealth. Yet some, with more stable business models, made it through and came out roaring. In the aftermath, guys like Frank Schilling cherry picked prime dot com assets for dirt cheap. Similar opportunities may appear again. In fact, they are already showing up (start looking.)

A hurricane is here.

The US government’s attempted intervention could be the calm in the eye of the storm. Its not a bad opportunity to tighten ship; that is, if you haven’t already.