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An anti-capitalism poster from 1911, published in the Industrial Worker, a socialist-anarchist newspaper
Fire, the wheel, the printing press...and the capitalist economic system.

When listing all the numerous inventions that improve our lives, one of the most important is usually ignored: the capitalist economic system.  With recent market turmoil causing some observers to claim capitalism itself has failed, it's apropos to take a closer look at the technology behind it.

Capitalism is an invention, no different than the transistor or the automobile. Like those others, it's comprised of many smaller inventions: the corporation, the bank, the stock market, commodities, securities, futures, etc. All together, they are a group of technologies invaluable for efficiently converting labor and resources into goods and services. Nothing we've devised has ever worked so well.  Most of our prosperity and standard of living derives from it.

Take Russia. By far the world's largest country and the richest in natural resources, it has a highly educated and hard-working populace. Yet when Putin took over, their GDP was barely larger than the tiny island of Hong Kong's, and despite quintupling in the last few years, it's still a tenth of the US economy. Or consider China which, after allowing a small bit of capitalist endeavor to penetrate its system, transformed into the world's fourth-largest economy nearly overnight.

One of the reasons so many people (including some misguided economists) have trouble accepting capitalism is its apparent simplicity. It just seems impossible that a system so seeming chaotic can outperform something intelligently planned by trained economists. But that assumption is itself incorrect. Where a planned economy is like a single-core processor, capitalism is a neural-net processor with millions of nodes. A socialist economy is run by a few government-appointed individuals. But in a free market, every time you buy or sell a product, you're adding a calculation to the system. Whether you buy a car, rent a movie, or get a haircut, you're contributing to the price and quantity of goods and services. Cut a trip to the mall because gas went up another 5 cents, and you've input data to force down the price. Go anyway and you've voted to raise the price further.

The system appears simple, but in reality it's an enormously complex, self-regulating, highly adaptive mechanism. And like most mechanisms, it works best when no one pours sand in the gears.

There's a strong theoretical basis that any intervention in a market reduces its efficiency. But still governments keep trying to tinker under the hood. Their shade-tree efforts invariably do great damage. Our current fiscal mess is a marvelous case in point. It's been cast as something too difficult for average people to understand, but it’s really very simple.

Consider.  A couple applies for a loan. They make $60K a year, and need to borrow $700K. Their credit history is poor or nonexistent. The house has doubled in value in recent years-- only because all the other homes around it have as well. And the only reason they can afford the payments is because interest rates are so low and they're being offered a balloon mortgage that, if rates climb or their house depreciates will surely bankrupt them.

Does it really take a rocket scientist to know how risky this is? And that a bank with a large portion of its portfolio in such loans is also in peril?

So why did so many banks take such risks for so long? Here's the key to the whole problem: government intervention. In a free market, interest rates will rise in step with rising risks. They didn't -- thanks to the Fed. And government-sponsored enterprises (GSEs) such as Fanny Mae, Freddy Mac, and the Federal Home Loan banks kept the music playing. With most of the risk ultimately guaranteed by the federal government, no one really cared.

The bailout will ultimately cost a trillion dollars. It's also left us an industry that's effectively been nationalized, and a precedent that will encourage future industries to take more inappropriate risks. But worst of all, we have people on both sides of the political aisle calling for still more government involvement. Capitalism hasn't failed here-- government intervention has.

What goes up must come down. When a market rises too fast, it must eventually decline. The longer one prevents that, the harder that fall will be. Very simple. It's a shame our politicians can't understand that.

But the technology itself is still sound. And if we just leave the machine alone, very quickly it will start working again.



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RE: now, that was pathetic
By Master Kenobi (blog) on 9/22/2008 8:20:32 AM , Rating: 5
The problem is that the government is to blame here. The government oversight of the GSE's (OFHEO at the time) mandated that Freddie and Fannie needed to take in more loans to help with lower income families that could not normally afford it to promote "the american dream". Had this not happened, the GSE's would have continued to say no, and refuse to buy those loans. Historically, the GSE's do not dabble in the non-performing loan category or the sub-prime category either. You can thank congress for this entire mess though, since they ultimately hold the leash to OFHEO. /Rant off.

*Disclaimer: I work for one of the GSE's*


RE: now, that was pathetic
By FITCamaro on 9/22/2008 9:11:44 AM , Rating: 2
Yeah I agree with you.


RE: now, that was pathetic
By rtrski on 9/22/2008 9:19:50 AM , Rating: 2
And whose oversight was it that pushed that policy change? (I'm not asking an intentionally leading question - I don't know the answer or how to search for it quickly, so I'll use your response as a starting point to do so.)

Does sound like a bit of a smoking gun though. I find it hard to believe all the "balloon" ARM mortgages the news likes to screech about solely lead to the current fiasco. Certainly they played a part, but usually those were used by people (at least in my personal knowledge) who could've afforded something smaller to get something bigger, e.g. the greedy overreaching, not the low income who wouldve' been below the threshhold).

Something else I rarely see mentioned is new fair-value accounting standards suddenly coming into play in the last year or so meaning everyone had to come clean about what their assets and derivatives were worth "if they were to sell them today". The accounting standards of course didn't create the risk, just suddenly made it glaringly visible to everyone in the room.


RE: now, that was pathetic
By FITCamaro on 9/22/2008 12:43:57 PM , Rating: 2
Bush and others pushed for more oversight of Fannie and Freddie back in 2003 and the Democrats wouldn't have it. They were busy putting their people in there so they could get huge amounts of money.

Love it how Obama says the situation is deplorable when Jim Johnson who's made $90 million of it is on his f*cking staff and one of his key advisors.


RE: now, that was pathetic
By Ringold on 9/22/2008 9:43:05 PM , Rating: 2
quote:
And whose oversight was it that pushed that policy change?


If he's talking about what I think he's talking about, it was the mid-90s Clinton years. Thank ACORN, the Marxist housing group, among others.

quote:
I find it hard to believe all the "balloon" ARM mortgages the news likes to screech about solely lead to the current fiasco.


Everybody is really to blame; government, banks, consumers, and especially lazy consumers who didn't understand the products they were using and probably didn't care to -- or worse, knew what they were getting in to, but didn't even care.

quote:
The accounting standards of course didn't create the risk, just suddenly made it glaringly visible to everyone in the room.


I'm not 100% set on it, but I think mark-to-market isn't quite the great beacon of light you seem to imply. Marking asset values to market is great.. when there is a market! I suppose technically there is a market for these toxic things, but it's so distressed and frozen up that these accounting rules would destroy modern finance for the sake of ideological purity. In reality, most of these things that're going for pennies on the dollar will work out, but god.. 3 month T-bills selling at par? Long bonds traded below 4% today for, I think, the first time in history. Where is the logic in marking to market when the market has gone absolutely insane? Marking to model seems to me to only delay disaster for a firm that bets wrong, not avoid it entirely, while allowing a bank to ignore the vicissitudes of the market in the mean time.


RE: now, that was pathetic
By rtrski on 9/23/2008 9:53:15 AM , Rating: 2
Thanks for the reply. After posting my initial question, I've started to see an awful lot of the same sort of responses in editorials re: Fanny and the congressional (and lobbyist) 'push' to get into low-income mortgages, etc.

And I think I agree with you about the 'fair value' accounting. Makes sense when there is indeed a market, but when there isn't, it becomes undefined in a hurry: how do you assign a liquid value to an aggressively illiquid asset? Still, if they'd been doing so all along, then the fact of the assets being illiquid due to lack of demand would, one hopes, have raised red flags long before they ballooned to the point they did...?

What's really pissing me off now is this continual Obama mantra that "deregulation" lead to this, when the deregulation he's talking about allowed comingling of banking and investment offerings (from his purported economic arch-nemesis, Gramm) and near as I can see is what allowed some banks and investment houses to actually merge and avoid the bailout bandwagon. The ones that had diversified in such a manner were the healthiest remaining.


RE: now, that was pathetic
By sigilscience on 9/23/2008 10:31:45 AM , Rating: 2
quote:
What's really pissing me off now is this continual Obama mantra that "deregulation" lead to this
He sings that song because he knows his followers are the type that believe that government is the cure to all ills.

When they hear "more government is the solution", they don't even think. Their brains click off, and they experience a warm flood of emotion over their entire bodies. Sort of like lying in a fresh puddle of urine.


"A lot of people pay zero for the cellphone ... That's what it's worth." -- Apple Chief Operating Officer Timothy Cook














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