In defence of capitalism

Following the recent credit crisis and collapse of several major financial institutions, many commentators have jumped to the conclusion that this proves that the case for free market capitalism is invalid and that libertarian ideals are dead. This includes comments to this effect by prominent people like Nicolas Sarkozy who said "Le laisser-faire, c'est fini" ("Free market capitalism is dead"). The view taken by Sarkozy and many other commentators is fundamentally misguided and suggests a misunderstaning of the real reason for our recent financial troubles. The real reason was not free market capitalism, but quite to the contrary, government interventionism.

Our troubles started with the sub-prime mortgage crisis, which, I think it is fair to say, was the event that triggered the remainder of the problems we have seen. The sub-prime crisis was not caused by free marketeers, but rather by two forms of interventionism. First, the US government offered backing to the two major mortgage backers, Freddie and Fannie. Second, having given them the guarantee of government backing, pressured them to expand their sub-prime lending - lending to people who in a normal (free market) situation would be ineligible for loans on the basis of their credit rating or ability to pay off their debts. Naturally, Freddie and Fannie were more than happy to comply. After all, if the government is guaranteeing your financial position, you can afford to take risks you ordinarily wouldn't take. So sub-prime lending flourished and as a result many people who were unable to pay off their loans were given loans anyway. A few years down the line, and, surprise surprise, Freddie and Fannie found themselves in a situation where they had vast amounts of bad investments on their hands.

There can be no argument that this sequence of events came about as a result of free market capitalism. Rather, it came about as a result of a misguided, interventionist policy to artificially expand home ownerships rates. This problem was compounded by an ultra-expansionary monetary policy championed by Greenspan et al., which further artificially expanded the amount of bad debt in the market.

Following the government bailout of Freddie/Fannie, their financial woes sent shockwaves of loss of confidence through the rest of the market, which triggered the remainder of the troubles we are seeing today - the collapse of banks and other financial institutions, the decline in world stock markets.

Nonetheless, despite the overwhelming evidence for the real cause of our problems, I haven't seen many politicians or media commentators call for measures that really address the problems, such as eliminating government involvement in the mortgage market, allowing for insolvent companies to go down, and a more restrained monetary policy. Instead, they're all too busy calling for the death of capitalism, while advocating bailouts and the injection of more credit.

Capitalism was never the root of today's problems. Interventionism was. And the only solution is to scale back interventionism and return to free-market principles.

I conclude with this picture...

11 thoughts on “In defence of capitalism”

  1. Peter Peter!

    I agree that free market capitalism is not the “cause” of the crisis (that’s a silly canard used by the left when they don’t have anything useful to say) but blaming Freddie and Fannie goes against the facts. The major cause of the subprime crisis was the explosion of private firms onto the mortgage scene. Take a look at percentages of the mortgage market as a function of time. The GSEs were actually declining when subprime was rocking up (due to their very nasty accounting scandals) while the deficit was made up in the private sector. See http://economistsview.typepad.com/.shared/image.html?/photos/uncategorized/2008/09/24/gse.gif

    The real issue, I think, was an issue of risk management. When it became possible to give bad loans to people who shouldn’t have been given the loans, and turn them, via a series on launderings into investments that didn’t look risky, well things were destined to fail. Thus those who gave you the bad loan were able to offload their loan and through the pretty magic of traunches and some wishful thinking about historical home prices disguise this risk. The way to fix this is obvious: we need those who give the loans to not be able to offload their bets.

    If you really want to go after the GSEs from a libertarian point of view I would think it would be more useful to attack the strange pseudo government status of the GSEs. This certainly causes consternation when the shit head the street and is one of the reasons the wall

  2. Ooops accidently hit the submit button.

    As I was saying I think if you want to go after the GSEs you should attack them as some pseudo private entities whose uncertain status contributed to the crisis. When the shit hit the fan, these was definitely a major cause of financial uncertainty.

    This is what I don’t understand about the pure strain of libertarianism: isn’t it obvious that there are “bad” markets, in that they hide risk and tend to cause bubbles? I can certainly agree that government intervention isn’t the best idea, but the gut reaction to defend every open market seem misplaced. (And yes I know the next person to blame are those who took the loans. But couldn’t it just be that there is a lot of blame that is spread across the spectrum: from the idiots who took the loans, to the mortgage system which offloaded its risk, to the ratings guys who totally botched their ratings in part because they were in bed with the investors, to the investors who created the appearance of AAA when really that was just a slight of hands, to those who thought there would be no need for a clearing house for their insurance bets?)

  3. “I can certainly agree that government intervention isn’t the best idea, but the gut reaction to defend every open market seem misplaced.”

    I totally agree. In an entirely unregulated market crises will occur from time to time. The basic reason is that humans are not infallible and many tend to bet and live beyond their means. How to stop it? Impose regulations (laws) that dampen the cycles. There will still be upturns and downturns, but excessive booms and collapses will be prevented.

    But I am not an economist and don’t know what the details of these regulations should be, although I do know that even some of the basic assumptions on which free market economy are based, are flawed. See

    http://knol.google.com/k/klaus-rohde/free-markets-and-free-trade-ecology-and/xk923bc3gp4/25#

    In this context, Paul Klugman has just received the Nobel prize for economics for showing that one of these assumptions, the principle of comparative advantage, is not valid. See:

    http://blog.une.edu.au/klausrohde/2008/10/14/free-trade-and-comaparative-advantage-nobel-prize-for-proessor-krugman/

  4. Government introducees a lot of risk in the market and the private entities cannot defend themselves selling that risk. (!!!!)

    Government artificially lowered interes rates, flooding the market with easy money and the government is not the cause of the bubble.(????)

    If you like government intervention, Mr. Bacon, come to Spain, we have a socialist government, and you will see the effects of interventionism: in October the number of new unemployed people was of 200,000, more than USA and UK together.

  5. Recommended read: http://www.thelandofplenty.com.au/. I disagree, needless to say. I think the issue of climate change is the best example as to what is going to happen if we pull government interventions out of a market system completely. We will hit the brick wall at unprecedented speed. I hold it with Nicolas Stern: ‘The science tells us that GHG emissions are an externality; in other words, our emissions affect the lives of others. When people do not pay for the consequences of their actions we have market failure. This is the greatest market failure the world has seen. It is an externality that goes beyond those of ordinary congestion or pollution, although many of the same economic principles apply for its analysis.’ More on the source here … http://en.wikipedia.org/wiki/Stern_Review. And an interesting Aussie version here … http://www.garnautreview.org.au.

  6. Climate change is the biggest market failure ever – I do not see any way to pull government from this one, sorry Pete …

  7. Dear Peter!
    You have not yet understood the esence of financial problem.PResident Nikola Sarkozy is right..Laisez-faire est fini…The real problem are derivative bubble,which create a black hole for monetary expansion,which is going toward hyperinflation in weimar style asociated with hyperdeflation in real economy.LAissez Faire policy are related with indipendent central banks which dictate the governments,and under these system the role of banks are to maximum profit.And these banks transformed in casino to absorb wealth of entire planet but in speculative maner.ANd not have credit for porduciton of real economy.Now these crisis is collapse of real e conomy ,and solution is find out of free market ideology in methods of FDR policy which is combination of ALexander Hamilton monetary policy in national central bank and science of Leibniz to increase potential for population density in km 2 and investmen in machine -tool which is heart of industrialisation……

  8. Dear Peter,
    Capitalism IS the reason why we are in an economic crisis. Capitalism does nothing for the country, but make people greedy and make the rich richer. Free market capitalism either will be overpowered by us or it WILL be the death of our great nation. If the founding fathers were still alive to see what we have done with this country! George Washington himself would trun over in his grave if he knew the atrocities we have commited because of capitalism! I am ashamed to call myself an American if this is what we stand for! Don’t think another depression won’t come because you’ll be liying to yourself! But there is a way out my brothers and sisters! Embrace the power of Communism. See that it isnt bad at all nor something you should hate or dispise. Sure there are evil dictators who use it for their own gain, but we dont have to be like that! We need a leader like comrade Vladamir Lenin. A good man who won’t turn to curruption or greed. Thats all communism needs for it to work properly. That and people willing to work for the goodness of the people instead of themselves or income. Hear me now great people of America! Communism is your way out of this abyss free market has dug you into!

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