Thursday, April 30, 2009

Socialism caused the financial crisis

"... the flaws inherent in capitalism led to the current crisis", says a socialist author espousing the renewed relevance of Marx.

That is an absurd conclusion.

The flaws inherent in socialism led to the current crisis.

Finance is quite likely* the most regulated industry in the United States. The United States does not have a "free market" banking system. What the United States has is a fractional reserve, fiat money system in which private deposits are insured by the government and the supply of money is openly manipulated by the Federal Reserve, a congressionaly chartered (yet private) institution.

Does that sound like a free market to you? As far as I can tell, nothing in the above paragraph is debatable, save my qualified use of the word "likely". The U.S. federal government attempts to centrally manage financial markets, especially our banking system and the money supply. This is "planning" in Hayek's worst sense of the word. This is the government thinking that it can do better than the free market. This is Keynes vision of "capitalism, wisely managed".

This is socialism, poorly managed.

Not convinced? Then let me mention the multiple "government sponsored enterprises" (GSEs): the Federal Finance Housing Agency, the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Association (Freddie Mac), the Government National Mortgage Association (Ginnie Mae), the Federal Agriculture Mortgage Corporation (Farmer Mac), and the twelve different Federal Home Loan Banks. We also have the Community Reinvestment Act, the Public Company Accounting Reform and Investor Protection Act (Sarbanes-Oxley), and the Farm Credit Administration just to name a few more government interventions in the financial markets. In order to manage our financial system, the Federal government requires no fewer than four agencies (beyond the already mentioned Federal Reserve): the Securities and Exchange Commission, the Office of the Comptroller of Currency, the Office of Thrift Supervision (both offices are part of the U.S. Treasury Department), and the National Credit Union Association. There also exists the Commodoties Future Trading Commission and the Pension Benefit Guarantee Corporation. And then there is the Federal Financial Institutions Examination Counsel, an organization just to help keep regulations consistent across all the other organizations.

That list is far from exhaustive. I'm not even going to attempt to cover the regulatory agencies responsible for the insurance industry, and don't think that state governments aren't in on the action. Every state has their own banking commission.

Could one still hold that the U.S. financial system is a "free market"? Is it really possible to think that is what "capitalism" is all about? If so, then we've discovered the problem--a misunderstanding of the definition of capitalism. Fortunately, "the internets" can help: the first paragraph in the wikipedia entry on capitalism should clear things up.

I am not here, today, to discuss the merits of any of the above government agencies or regulations. Not all regulation is bad; the government is responsible for protecting property rights and protecting free, competitive markets. My intent for this post is merely to make clear that the U.S. government did not "deregulate" the financial services industry. That's just a silly notion. Given the level of government intervention and manipulation, I do not see how one can seriously refer to the U.S. financial system as capitalistic. As such, there is no support for the belief that capitalism led to the current crisis, no matter how often you hear it said.

To the contrary, it is easy to demonstrate that the banking system failed because of regulation. Bad regulation. Incompetent regulation. A failure of government planning. I believe most rational people, if they examine the facts, can quickly see how government intervention is the root cause of the meltdown. It distorted the market. It created perverse incentives. It privatized gains and passed losses on to the tax payers. It had the "Greenspan put". It coerced banks into extending credit into questionable areas (PDF link). The list goes on and on.

One last point: perhaps you generally agree with the position above (it is usually not too difficult to convince people that our government is incompetent), except hold on to the notion that our banking system is not a socialist institution. That is fine, because it means that now the debate is reduced to one merely of degree, with "perfectly free markets" on one side, and a "wholly centrally controlled economy" on the other. Clearly, we are somewhere in the middle. Our banking system is in the fashion of Keynes's "Third Way".

The current crisis in the financial system illustrates clearly the fatal flaw in Keynes's logic: specifically, who could you reasonably expect to be the wise managers of capitalism? Of course, Keynes envisioned the role being fulfilled by altruistic servants as educated and intelligent as himself. That flawed logic is to be found in all socialist thinking. How could such an intelligent man ignore the fact that the moment you invest such power in people is the same moment that you politicize the process, because everyone who has anything to be gained or lost by the ensuing decisions will mobilize to protect their interests? Just look at Keynes's theories in practice: How wisely managed is (was) the financial system? How politicized had the system become? How many groups had lobbied the decision makers to their own benefit? How many politicians peddled their influence?

As for me, I take the Hayekian view that planning is a form of socialism. If you do not (perhaps because you reserve the term socialism to refer to Marxian communism), then I am happy to propose a revised conclusion:

The flaws inherent in centralized planning led to the current crisis.

The result is the same. This "planning" is Keynes's "wise management". It is the notion that a centralized institution can make better decisions for the collective than if individuals are left to make decisions for themselves in the form of Adam Smith's "invisible hand". It's an emotionally attractive and politically expedient argument. Look where that logic got us. It failed.


* I say "quite likely", because I honestly don't know how you go about proving such a thing. Perhaps by measuring the number of words contained within all the relevant laws and regulations? Or perhaps by measuring how much money firms spend maintaining compliance. And then, of course, you'd need to normalize it somehow, perhaps by the industry's total revenues or number of employees. So, it might be possible that the manufacture of fissile material is more highly regulated than the U.S. banking system. Regardless, I doubt that few people with a modicum of knowledge about how the U.S. banking system works would disagree that the U.S. Government plays a heavy hand in our financial markets.

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