[malldian]

Disregarding whether or not you agree, how could you specifically defend a free market capitalistic economy after its recent failure?

Interesting discussion I had in class today..

 

[Xena]

The only "failure" is when governments bail out companies that go down because of their own mismanagement and stupidity. If they fail, they fail. Let them answer to shareholders and shareholder lawsuits. Let those more able come in and do a better job.

It isn't capitalism that fails, it's intervention that cripples the natural ability of the free market to survive.

 

[marvin]

Quote:

Originally Posted by malldian /img/forum/go_quote.gif Disregarding whether or not you agree, how could you specifically defend a free market capitalistic economy after its recent failure?

Arguing semantics, we don't have a free market capitalistic economy. The functioning parts of the world have government regulated capitalist economies, with varying levels of regulation. The system's failure is also arguable. Without other systems as a reference, it's impossible to tell whether or not modified market capitalism would have performed better or worse than any other system, current hiccups included.

Knee jerk reaction would be to point at Russia and China. It ain't perfect, but it's a damn sight better than the alternative.

 

[malldian]

Consider all this to all be coming from the devils advocate.

@Xena: Fairness aside, would the economy be in a better state had every company that has been bailed out fail?

@marvin: Compared to a more regulated system where the US was producing a moderated yet stable growth 15-20 years ago, the current situation is certainly a failure. If not, although it may be better than a completely planned economy, doesn't a more controlled economic system lead to more stability?

 

[Arainach]

I don't think he's referring to the collapse itself, he's referring to the CAUSE of the collapse - the huge growth in unsafe and unbacked mortgage assets and bad loans piling up to the point where even the largest companies collapsed. That wasn't the result of regulation, that was the result of lack of regulation.

 

[Sherwood]

What leads you to believe we had a more regulated system 30 years ago? That goes against my understanding of our economy.

 

[malldian]

Edited in ten seconds, meant 15-20. See the period of great moderation.

 

[imademymark]

well economics doesn't say that the free market is perfect nor that it doesnt fails, it says it is best given the circumstances.

although i do think george soro's argument on the market settling at a disequilibrium very fascinating intellectually, even he conceedes that the government might not be able to do any better.

 

[minimus]

Quite a few academic papers in recent years demonstrate that the demand curve for risky assets is upward sloping for highly levered financial institutions (banks, broker/dealers, insurance companies). The reason is that they target lower leverage ratios after periods of unexpectedly high credit-related losses. So, as asset prices fall, these institutions sell more assets. Bernanke has referred to this as the "financial accelerator". Upward sloping demand curves do not lead to good outcomes, so in times of severe stress the banking sector does not operate as a well-functioning free market. Now, a few months ago one could have argued that intermediation provided by banks and other financial institutions is not important and that insolvent banks should be allowed to fail in a free market system without severe consequences to the rest of the economy. Recent data suggest to me that consequences of these failures have been severe. Bailing out Lehman probably would have required a government subsidy of $40B-$60B. Letting it fail has been far more costly, as evidenced by the failure of the $700B TARP program to so far stem the bleeding in the financial sector or the real economy. So, the market failed. Read Hyman Minsky (a well-respected academic economist) if you want a good description of how an unregulated financial system is prone to failure when it is not properly regulated.

 

[marvin]

Quote:

Originally Posted by malldian /img/forum/go_quote.gif @marvin: Compared to a more regulated system where the US was producing a moderated yet stable growth 15-20 years ago, the current situation is certainly a failure. If not, although it may be better than a completely planned economy, doesn't a more controlled economic system lead to more stability?

Problem is, there is no consensus on what caused the Great Moderation. A sampling of the theories follows: * improved inventory control and supply chain management * more sophisticated investment instruments to manage risk * better economic policy * technological gains * plain dumb luck. Without knowing why it occurred, there's really no way to consciously extend that period or replicate it.

Note that it's also quite possible that "more sophisticated instruments to manage risk" bit could have caused both the Great Moderation and the current collapse of the financial industry.

 

[breakfastchef]

I do not think 'free market capitalism', as you refer to it, failed. What did occured was a situation where a lot of very smart people took advantage of U.S. government relaxation of debt ratios and forgot to do a proper risk management profile. This led to a leverage-driven bubble that increased prices of things like real estate and commodities way beyond their proper value. When the cerditors wanted out, the big institutional investors were forced to sell short (driving down the market) to cover their debts. Add to that an insurance giant like AIG, which insured many institutional investors against losses, to have to come up with cash it did not have on hand and you can see how the domino effect rippled throughout the economy.

Essentially, we experienced a 'run on the bank'. Because so many people panicked and wanted out now, none of our stellar brokerages, banks, insurance companies, etc. could come up with that much cash on such short notice and eventually went bankrupt, were bought out by another firm or bailed out. The recent crumbling of our financial systems does highlight our affection with greed and a total disregard of risk management.

Now, to the rest of the world...no one held a gun to their heads and forced them to buy anything toxic created in the U.S. Problems in the EU, Asia and BRIC countries are also a problem they created. While the adage that 'when the US sneezes the world gets a cold' is still true in many regards, the global problem is worldwide greed.

That brings us around to your further question about the merits of a more controlled economy. Well, the EU is a perfect example of that. Less than stellar growth, more regulation, relatively high taxation of member nations leads to boring growth. I would rather have a situation where the US maintains a fluid system that lowers tax rates, encourages risk-taking, and creates new opportunities.

 

[malldian]

Again, just poking holes in the logic.

How is a bank run and liquidity crisis not a "feature" of market economies? Was it government regulation that led to this crisis or the lack of freedom in the marketplace? If so, how would more freedom not have led to the same problem?

@minimus: Minsky is very interesting and certainly relevant in this discussion, thanks for the mention.

 

[Uncle Erik]

The real problem is lack of accountability. If you gamble everything and win, you get the profit. If you gamble everything and lose, you get a bailout. There's no feedback loop, no disincentive to making bad bets, so reason goes out the window. Any system that has no feedback or negative consequences spins out of control sooner or later.

I think there are two good solutions for providing feedback and consequences to the market:

1. Shareholder liability. If you own a piece of a company, you should be held liable for it. This would be met with howls of protest, but you can be sure that institutional lenders and others would thoroughly vet any investment and yank funds at the first sign of trouble. That would be a powerful disincentive to cook books and fraudulently misrepresent assets. It would have costs for administration and speculation would choke back. But there would be stability and conservative growth.

2. Criminal prosecution and long mandatory minimum sentences in Federal prison. You should not be able to fraudulently misrepresent investments, then demolish the company's pensions, fire thousands, then walk away with a $10 million bonus (after being bailed out, no less) because "it could have been worse." People who do that should be promptly indicted for fraud, among other crimes, tried and given 25 to life without possibility for early release. This sort of fraud is deliberate and premeditated - the same reasons crimes like first degree murder and counterfeiting have heavy penalties. No one ever, in the heat of passion, decides to screw investors.

These would cut back on spectacular growth, for sure, but stability is worth it. Stability drives foreign investment, too, which would benefit us while giving the world a safe place to put money. And fair is fair - fraud is the same whether you're passing bad checks or lying about bond ratings.

 

[aaron313]

I'm no economist, but I read something interesting last night. When you look at many countries across the word, the correlation between stock market drop between Oct '07 and Oct '08 and freedom of that country's market, is negative. I have no idea if that data is actually important, but the correlation was not positive (as many would predict), so anyone who tells you that free markets cause problems like this probably has an agenda (or is just heavily biased). Anyway, that's just what I read, so I have no real opinion on the subject at this time.

 

[elrod-tom]

Quote:

Originally Posted by Arainach /img/forum/go_quote.gif I don't think he's referring to the collapse itself, he's referring to the CAUSE of the collapse - the huge growth in unsafe and unbacked mortgage assets and bad loans piling up to the point where even the largest companies collapsed. That wasn't the result of regulation, that was the result of lack of regulation.

Actually, one could argue rather well that it was neither regulation or lack of that caused this most recent mess. It was, in fact, to a large degree caused (IMHO and that of others) by the intervention of other than free market forces into the mortgage banking industry.

Specifically, faulty legislation (the Community Reinvestment Act) opened the floodgates for all sorts of risky mortgages, which were explicitly covered by Fannie Mae and Freddie Mac, who were in turn implicitly covered by...you and I, the taxpayer. Many folks who would have NEVER qualified for a traditional mortgage were getting nothing down, interest only payments, supposedly covered by the full faith and credit of the US government. This worked so long as the economy kept growing and housing values kept rising. When things went bad economically, housing values tanked and the whole house of cards collapsed.

So I'd argue that it was government (favorite old quote...Hi, I'm from the government and I'm here to help) intervening in the otherwise well run market for loans that caused the problems that we've had the last few years. Couple that with all the political payola that Fannie and Freddie were spreading around DC, and it's a government backed protection racket to boot. Were not some of the extra-free-market forces unleashed upon the free market, chances are good that we would not have suffered nearly so much for it.

Actually, this is one of the reasons that I'm not too crazy about this whole bailout of the auto industry. The LAST thing that we need IMHO are the politicians largely responsible for turning a well-run industry on its backside trying to TURN AROUND an industry. Most of these thieving bastards have never held a real job in their lives...what do THEY know about running an auto manufacturer?


BTW - my credentials:

BS Economics; MBA; MS Taxation

FWIW.