By Patrick Watson*
Those who support free-market economics say it is the best, most efficient path to maximum prosperity for everyone.
In other words, everybody wins in a free market—not equally, but each person at least has the opportunity for a prosperous life.
I agree with all that, except the “everybody wins” part.
In fact, free markets don’t work well at all unless certain people lose. Otherwise the entire system fails and everyone loses. Which is happening right now.
Photo: Getty Images
Forgetting the Lessons
Neel Kashkari, president of the Minneapolis Federal Reserve Bank, is often in the news because he dissents from the Fed’s rate-hike decisions. He previously worked at Goldman Sachs and PIMCO and was assistant Treasury secretary overseeing the crisis-era Troubled Asset Relief Program (TARP).
After running one of the top bailout programs, Kashkari now thinks the “too big to fail” banks are, well, too big and should be broken up. I imagine that makes for some interesting conversations with the banks in his district.
Kashkari went on a little rant at a Howard University event last month. Here are some quotes my Twitter pal Pedro da Costa reported for Business Insider.
- “We are forgetting the lessons of the 2008 crisis.”
- “The shareholders got bailed out. The boards of directors got bailed out. Management got bailed out. So from their perspective, there was no crisis.”
- “No other industry is levered like the banking industry. If we double the amount of equity banks have, we could go a long way toward resolving the problem that too-big-to-fail banks pose.”
- “If it were up to me, we’d be increasing banks’ leverage ratio, not decreasing it.”
Those last two comments are important. Banks profit mainly by lending money that was itself loaned to the bank by depositors and bondholders. This gives them leverage, which makes them vulnerable to losses when borrowers default.
As a result, there’s a constant tension. Bankers want more leverage so profits will be higher. Regulators want to allow less leverage so the banks are less likely to fail. They meet somewhere in the middle.
The Fed manages this balance and does a pretty good job of it... until something like 2008 happens.
But here’s the problem: Our bank-stability apparatus—the Fed, the FDIC, occasional bailouts—encourages banks and other lenders to take unwise risks because they know (or at least believe) they’ll get rescued.
And that brings us back to free markets and losers.
Photo: Getty Images
Hiding the Message
We heard a lot in the crisis, and still now, about people taking out loans they couldn’t afford. Obviously, that’s a bad idea.
But every loan has two sides: borrower and lender. Both have responsibilities.
Just as borrowers shouldn’t overstretch, lenders shouldn’t over-lend. That’s partly how we get crises like 2008.
In theory, the free market imposes discipline on both sides. It certainly does for borrowers. Default on your mortgage and every future lender will either deny you credit or charge you much higher rates… and rightly so.
But on the lender side, responsibility for mistakes stays hidden. As Kashkari said, bank executives and directors who made bad decisions leading up to 2008 felt little punishment.
So, the system tacitly promotes irresponsible lending. The free-market way to prevent this is for irresponsible lenders to lose all their money. It would send other lenders a message: “Avoid doing what they did.”
Government bailouts keep that information from the people who need it. The result: an unstable banking system that builds up unsustainable debt and periodically implodes.
Photo: Getty Images
Raising Taxes
This isn’t just a US problem. An April 18 Financial Times story reported on some African countries slipping into a debt crisis. Here’s an excerpt:
With the number of countries already unable to service their debts doubling in the past year to eight, officials at the International Monetary Fund are urging all African countries to raise taxes to provide more scope for paying interest, which has increased to levels last experienced at the start of the century.
While we don’t know the details of these troubled loans, we can infer a few things.
First, it’s not new information that some African governments are unstable, corrupt, and have trouble servicing their debts. That has been the case for decades.
Second, anyone who lends money to those governments should know those risks and price their loans accordingly. These lenders apparently didn’t.
Whose fault is that? Not the borrowers’, and certainly not the citizens’ who the IMF now insists pay higher taxes so the lenders get their interest.
What should happen here is…
- IMF butt out, and
- Those lenders lose their money.
That would teach other lenders to require sustainable, realistic loan terms and interest rates. It would be short-term harder on the borrowers, but in the long run help free them from perpetual debt serfdom.
Don’t Blame Capitalism
Similar things happen in the US every day. I don’t think another banking crisis is imminent, but we’ll have one eventually.
When that crisis comes, some people will want to blame capitalism—but the real culprit will be the lenders’ lack of market discipline.
We could avoid this, or at least make it less painful, by taking the kind of steps Neel Kashkari recommends. But don’t hold your breath.
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*Patrick Watson is senior economic analyst at Mauldin Economics. This article is from a regular Mauldin Economics series called Connecting the Dots. It first appeared here and is used by interest.co.nz with permission.
75 Comments
I think the problem becomes political because the people who ultimately suffer are mum and dad investors (i.e. voters).
The same thing happened in NZ with South Canterbury Finance and AMI in that the market wanted to punish those entites for bad investments and not having enough re-insurance. But the people who would have suffered would have been investors and uninsured voters. Political call to spend taxpayer's money to bail out stupid people who took unacceptable risks in investing in a dodgy finance and insurance sompany.
Yes but in the end the people suffering are the mum and dad who are not investors but tax payers and who did not participate in any investments at all.
I know my opinion is extreme but think that the US should have let the banks, car manufacturers and other large companies go bust during the GFC! Yes it would have led to large layoffs and a sharp depression but I think, now 10 years later on, we would all be much better off. Also it sends a very wrong signal, namely, if you're too big, don't worry, we will bail you out if you make poor choices. It is the essence of Capitalism that you reap your rewards or pay the price depending on the outcome and that is the ultimate motivator. The US decision to bail out the big companies was very un-captitalistic.
I believe in accountability, both individually and for companies. I'm an investor and I want to reap the benefits if my investment choices are fruitful and I accept that I will lose (without blaming anyone else) if my investments fail.
If it was only "Ford" or only "goldman sachs" I would agree with you 100%. When its all of them you cannot let them all fold without "causing" a second great depression. and the secondary effects are mind boggling (pension funds collapse etc etc) What should have happened in 2008 is they should have been Nationalised and those in charge sacked, the entity cleaned up and sold out as a going concern. I'd like to think the shareholders would also have been allowed to go to the wall, but the consequences of that seem dire to say the least. ie a very difficult if not impossible course to steer without having a Great Depression on your hands.
Yvil, is that you? Never struck a comment from you with such dark prospects. Not that I don't agree with you, it's just that you've performed a 180 degree turn. I guess you can consider yourself as a self annointed member of the DGM! I extend a warm welcome to reality. Shed that debt and embrace true freedom!
Well RP, second day of early retirement for me. I have enough in the pot to see me through, albeit I'm not feeling like I have the true freedom you talk of. How long does it take to shed the feeling of guilt that you could be contributing to society but are able to sit on your butt doing nothing? It's an indulgence that doesn't sit well with me so far.
Home maintenance, then off to do the same at my parents' place. That should use up a couple of months. After that I have no idea. I suspect I'll need to look for some form of paid or even charity work to maintain my sense of sanity and self worth. I'm beginning to empathise with Clarke's outlook now as effectively with a wife still working I'm a kept man.
Excuse me but mom & pop investors trying to earn enough to live off without being a burden on the rest of us lost NZ$5Billion when NZ finance companies collapsed.
Try Reading from page 21 to learn why http://aut.researchgateway.ac.nz/bitstream/handle/10292/1425/2010%20ARA…
Or as you may not access above here’s the NZ Heralds take;
https://www.nzherald.co.nz/nz/news/article.cfm?c_id=1&objectid=10527280
I wasn't justifying the bail outs. Merely pointing out that there are political factors in bail outs that need to be taken into account to explain why the Governments take such action.
Personally, if you are happy enough to risk your money chasing the higher returns finance companies offer then suffer the consequences. There is always Kiwibonds for those averse to risk.
I agree with the buyer beware approach but think you are being naive if you think politics doesn't play a part when a Government is considering a bail out.
The same thing happened in NZ with South Canterbury Finance and AMI in that the market wanted to punish those entites for bad investments and not having enough re-insurance. But the people who would have suffered would have been investors and uninsured voters. Political call to spend taxpayer's money to bail out stupid people who took unacceptable risks in investing in a dodgy finance and insurance sompany.
The SCF bailout was a farce and immensely political. Many SCF investors were South Island "old money" as opposed to the starry-eyed suburban investors who were fleeced by Blue Chip and Hanover. Arguably, the impacts on SI rural economies would have been greater than the battlers in Glenfield losing whatever investments they may have had. The media barely touched this. Socialism for some; hard knocks for others.
Any market, society or economic and political system has "winners and losers", although I prefer the say people with more and people with less becsuse we, as humand are all different. Some of us do more and some of us do less, some people are more efficient than others, some are more talented some are born more priviledged (1st workd countries) others are less (3rd world countries).
The communist notion of "everyone having the same" is beautiful but ultimately utopian and leads to the majority having less as demonstrated by the spectacular collapse and poverty of the countries that pursued communism for a few decades.
Actually, Japan operates much like a "socialist" country. Yes, they have suffered from a "spectacular collapse" and they have poverty, but they're still one of the world's primary creditors.
As for their collapse, why is that the Anglosphere nations think they have nailed the elixir of bubble economics?
A society of winners and losers inevitably sees an ever shrinking number of big winners, holding an ever increasing amount of the resources while the pool of losers continues to grow. That is what leads to spectacular crashes, including "communism" where that is taken to its utter extreme, same result, collapse.
We should not lose our heads on this issue .
I have long been an advocate of steps to regulate Bank lending , esp. where there is patent evidence of reckless lending in pursuit of profits
And yes , when Usuary is at 25% per annum plus , there are going to be losers .
On a more general note , the alternatives to the free market economy have been tried and tested , and trust me I have lived and worked under a Marxist Government , and it was terrible .
Banks dont lend against property in a communist state , they cant .
The free market works , open competition and the profit motive is the most efficient way of getting goods and services to those who need them , everything from getting the the apple you buy at Pak and Save into the store , then on to you , to the chippy who builds your house............ its the profit motive and competition that sets the price and delivers the goods .
To assume that Capitalism is some kind of one-sided race is facile , but I agree that the hand of the state should be there to protect the vulnerable
There perhaps need to be moral/ethical codes of conduct that keep the system in check. At what point is excessive profit, too much profit and at what point is the CEO's salary too much regardless of performance or negative outcomes on society?
E.g. we have bank CEO's earning millions p/a to regulate a system (regardless of outcomes) that sees average people struggling to get by and requiring government support to survive (and further debt to survive). At what point does the average person stop and go, hey, this system is %#@#, I'm out. I guess we'll see rising dissent before it breaks down (oh, what just happened in the last US and perhaps NZ elections?)
Come on Boatie, we've discussed this before - the Free market doesn't work. the "Free" means free of regulation and Government interference. The problem is it doesn't mean free of manipulation, and most players are working pretty hard to manipulate in their favour. The whole point of regulation is to prevent manipulation. In a perfect world we shouldn't need regulation, but as we know this world and the people in it are anything but perfect. The markets work best when EVERYONE gets a fair shake, and that is the point of this article.
They bailed out the players not the little guys. Of interest is the statement at the beginning that says effectively the depositors loan their money to the banks. That should be the legal status of depositors funds here, but isn't.
Yes Rick I scanned article
Maudlin E CON omics
That’s a red flag for a start
They make $ from peddling investment info
I laughed reading the writers assessment we were not about to have another banking crisis.
Read a Nomi Prins new bookout now ( her previous book All The Presidents Bankers was exceptional)
I think the sooner we better acknowledge the interdependent nature of our society, the sooner we will accept that unregulated capitalism is going to have its challenges. Sure it generates competition and improvements in technology/products/services, but I think if taken too far, is causing a number of negative side effects on our people/societies. For the older members of this site a question; were depression, mental health and suicide rates ever this bad in your experience in New Zealand? Or could this be an outcome of capitalism gone wrong? i.e. the pressures to beat other people financially in order to get established in society can't be healthy - it creates selfishness which I worry in time could cause an irreversible breakdown in the values of our society.
@Independent observer, there is nowhere where Capitalism is unregulated in some way , there are always legisaltive constraints or economic constraints .
I agree with you that some of our social ills , and societal problems such as inequality are exacerbated by the "system"
I also agree with your contention that selfishness is a factor in inequality, but thats not new in society
But to be fair , the poor have always been with us , and its how we help them or our attitudes towards the poor that matters .
I still hold the view that open exploitation of the poor ( by cash lenders and roaming truck stores) needs to be curtailed .
We could start with education in our schools and then a law change to limit interest charges to say 24% per annum for personal loans with a cap at 100% of the loan amount in the event of default
We do not have True Capitalism we have Crony Capitalism
This will not change as long as humans are regulating
NZ couldn’t even regulate Coporate Governance in its Regulated Finance Companies which actually were required to not lie on prospectuses but did anyway and got away with it The result is history $5Billion of mom & pops retiree money gone.
I look forward to Artificial Intelligence in the vain hope it may provide better controls because humans are utterly flawed. Take our POTUS & GOP for example.
This was a strange article linking capitalism with the recent bank failures as they had realistically nothing to do with each other. As per the article “Banks profit mainly by lending money that was itself loaned to the bank by depositors and bondholders. This gives them leverage, which makes them vulnerable to losses when borrowers default.” - incorrect, banks profit from creating money from nothing, deposits go towards maintaining the reserve requirement. Until people understand money creation and the issues it causes (which is what this article was really about) we won’t be able to improve much.
Right problem, wrong cause identified!
Mr Withay
Suggest you get a copy of Nomi Prins “All The Presidents Bankers” & her new book http://www.nomiprins.com/
One cannot talk of a Free market and then a system.
Either it is a free market or it isn't - it cannot be both at the same time.
It is the system that bailed out the banks.
It is the system that allowed those bank shareholders, directors, managers etc to not learn any lesson.
It is the system that failed not capitalism or a free market as neither of the latter are in real existence.
Would people deposit their money into a bank in a true capitalist free market without doing due diligence and/or having some type of security? The only reason people throw their money at the banks is because of the presence of the system......they think safety, they think someone else (the system is now responsible for
their loot)......and how many actually take a close look at the system?
Trusting the system is like a leaving a 3 year old in charge of the steering wheel while driving down the road at 100km per hour.......
How would you do due diligence on a bank without all the regulations?
They wouldn't have to release data, they wouldn't have to adhere to any accounting standards, so could get rather creative with the data, without regulations (and regulators to enforce it) the data could be complete fabrications in the first place.
Interesting article from Michael Reddell the other day, where he discussed Treasury data on internal migration. It showed that the entire increase of Auckland's population was due to migration from overseas. It's a pity we didn't charge them $100,000 each to pay for all the infrastructure they need.
https://croakingcassandra.com/2018/05/02/new-zealanders-leaving-aucklan…
DGZ, its true that free markets (capitalism) can't function without some losers. That's what's great about ringfencing. It tips the scales just that little bit further to the FHBs. Tenants limited breathing financial room is overall limited and that will dictate the possibility of passing this cost on (unlikely) Ring Fencing on its own doesn't entirely solve the wealth gap overnight. Together with other good hearted Coalition policies, you must agree we are sure heading in the right direction - right?. So I guess its Landlords that are are the losers here. In the event of a correction outside Government this particular policy then people encountering losses are more widespread.
More importantly, did you experience any emotions seeing your hard working colleagues economically evicted from their home city?
And how did you reconcile those emotions with the part of you that gloats and cheers on horrifically expensive housing?
Did the thought cross your mind that if you were born at a different time or had different luck that could have been you?
What does your employer think about the matter? Is their business becoming unviable due to Auckland's death spiral? Are they going to shriek that we need more mass immigration because they "can't find workers"? Why aren't they paying a good salary for their workers to live on?
When a profit-making entity starts to become "too big to fail" and all its losses must be socialised to prevent mass hardship and a general recession or depression you realise that this entity is no longer entitled to behave like a private profit-making entity and must be treated more like an essential public utility and regulated as such. Banking and finance should be highly regulated and much more boring. Like it was in the post-war Keynesian phase. Finance should grease the wheels of the real economy, not subsume it and destabilise it. This is obvious to anyone objectively looking at the situation. Vested interests however are powerful and the populace are easily hoodwinked and distracted.
Retired Poppy, seriously you need to get a hobby or something to do that will stop you moaning about how other people have been successful and you havent!
Wishing everyone that is more financial than yourself will make you even more bitter and twisted!
It is what it is, there are people who,take action RP and others that don’t and that is why you should not be critical of others success!
He is just a grumpy negative old boomer who got lucky because he was able to buy some assets when they were a lot cheaper than they are today or so he says. All he did was buy some houses in a town that is currently number 17 in New Zealand housing values wise. Anyone could have done that. His big mistake is he bought theses houses (or so he says) in an area prone to major shakes. Not a smart move. A class example of putting all ones eggs in one basket and the wrong basket to boot. Rents and values are getting worse by the day for him and the new government is tinkering with the market he is in hence he is becoming very grumpy and angry. In not having a property portfolio in Auckland he has let his family down. His main problem is he knows it all and that arrogance and ignorance has trapped him in a town that has a very limited future. Look to seeing him getting grumpier in the future.
Free markets & capitalism certainly give everyone the opportunity to prosper. The issue here is that NZ is really only in the younger days of free markets & capitalism. With a strong socialist background, we have a long way to go. That is evident in daily references to the Government not doing enough to solve our problems.
Perhaps its time to realise that we ourselves need to solve our own problems and strive for success, not by taking down the next person but by working together to get more money into the country!
I would argue that the repeated failure of ACT to get anywhere in NZ politics is clear evidence the NZers don't want to head towards the free market and capitalism you seem so keen for.
I would also argue that the world in general has consistently moved away from free markets to markets that are more regulated to prevent monopolies/oligopolies and other forms of market manipulation.
I don't think ACT's true support shows up in voting e.g. I likely would have voted ACT every election in the last 30 plus years but I couldn't stomach it being a vote that possibly allowed the Left to prevail so I've voted National every single time. Ironically, it is National who have led to my redundancy as their economic management meant that there is insufficient distressed business consultancy work to go around. I'm holding out hope that the COL will fix that soon. It is completely indulgent to not contribute economically when able to do so, even if I don't need the cash.
Epsom proves my point. There is latent support for ACT not showing in the nationwide polls. Ideally, I would be able to transfer my vote, which is what I supported in the options, but that isn't the reality. Second best is to vote tactically to give a right of centre the best chance at being the Government. Politics is a broad church, I can occupy any pew on the Right side.
No, it does quite the opposite. Under MMP once ACT had that nice safe seat in Epsom (with a wink and nod from National), then your party vote for them was guaranteed not to be wasted, they would get another MP for every ~0.8% of the party vote they managed to get. At worst your vote swapped an ACT MP instead of a national MP, but more than likely with the overhang you just got an extra ACT MP in. That was the whole reason ACT kept getting Epsom handed to them on a plate, National handed it to them because the overhang meant it cost them nothing, and gave them a free ACT MP (or more).
And that was only after ACT declined from a party that was able to get in on its own merits, back when it managed to get 7% of the vote and didn't need the Nats to open the door for them. If there was any real support for the far right policies ACT would have grown from those days, not declined,.
The Epsom deal is useful if there is an overhang. However, in 2014 they received 0.69% so it would take a very coordinated swing to get an extra person in and the National Party encouraged people to vote for them, not ACT outside Epsom. It was an enhanced outcome if ACT did get a swing.
I support ACT in principle but not in vote. Am I the only one in NZ? Who knows but your assumption that the right is weakening is flawed. Like it or not over 45% of voters did not want the COL and when we won power back (it will happen, it always does), you will see us start to clean up the mess left by Taxinda and get this country back on the right track. Make the most of your time in power, because it won’t last, neither will the policies. That’s politics.
If the Epsom voters actually voted national, it would cost national their ACT lapdog vote. The fact that everybody knows that ACT are going to get a seat, and don't have to worry about hitting the 5% threshold and they still get no votes shows exactly how little support their is for their politics. Hell, if it wasn't for National throwing them a bone they'd be as relevant as the legalise cannabis party.
Where do you think the ACT voters of old came from and then went to? National is the answer you are looking for. Those voters are currently reflected in the National voter base, which is the largest single party in NZ.
How the National/Act split is each election is of little concern to me. What’s important is that my vote gives that bloc the best chance of forming a government. I align to ACT and vote National. To say that the more Rightest politics is on the decline is highly debateable if you start from the premise that all ACT oriented voters actually vote ACT. They don’t.
.. is the author of this article a Malthusian ?
The argument that capitalism can't win unless some others lose is 250 year old bunk'em Malthusian clap-trap ...
.. in any economic system some do " better " than others ... its human nature , fella ... we/re not all born equal .... nor do we all behave the same , thank God ! ...
The role of the government of the day is to provide an equal playing field ... so we can innovate , dream , plan and scheme .. build our families and friends .... stare to the stars and imagine what could be ....
... and pray that with the rising economic tide of capitalism all boats will rise ... not just those of the leaders of industry ,,,
Not sure whether he's provided a Mathusian analysis but I'm sure isn't a Marxian one. And I think that if you're a trained economist and you're saying capitalism will fail, it is remiss not to apply a political economy (i.e., Marxian) analytical approach.
The current state we find ourselves in relates to a breakdown of capitalist production - arising from the over-accumulation of capital in conjunction with depressed wages and reduced purchasing power on the part of the working class.
This is the technical breakdown of the dynamics of capital accumulation, that Marx signaled.
We see news stories every night in evidence of it.
Privatising profits and Socialising losses is not going to change, ever.
Capitalism and Democracy have veered very far from their book definitions. The practices of both are very different nowadays.
The nexus between the Haves and Government is deeply entrenched in the last few decades..
Call it Lobbying, Corruption, Revolving Door, whatever...
... whatever you call it .. the drivers of capitalism ... the big-bang-for-your-buck innovations have traditionally come from lone nut-cases , driven individuals or small corporations .... not from big government departments nor from big businesses such as Feltchers or Fonterrible ....
If a government is benign , and genuinely wants its citizens to flourish , and its businesses to prosper ... then it sets in place a small bureaucracy with clear black & white rules .... and stands back , allowing the natural order of mankind's constant need to progress and succeed , to unfold ...
Capitalism today is a sick puppy. I can think of 5 reasons why..
1. Financialisation; Is now asset stripping the middle and upper middle class. (think home ownership rates)
2. ZIRP; Only the privileged few have access to the river of zero interest rate cash which is used to speculate on real assets, thereby concentrating wealth at the top. (think carry trade foreigners buying Auckland homes, Think usurious interest rates charged to the poor)
3. Too Big To Fail; Even with the privilege of ZIRP the big plays get a one way deal. Reckless behavior is rewarded with bail outs if you’re sufficiently big. (think South Canterbury Finance, Would ANZ the biggest bank ever be subject to OBR? Really? Profits guaranteed, losses backstopped)
4. Piketty Effect; – Return on capital is greater than income growth. A feedback loop involving points 1,2 and 3 results in the concentration of wealth in the hands of fewer and fewer.
5. Destruction of Trust; As the majority of people become victims not beneficiaries of the economic system it becomes increasingly important for the main stream media to attempt to control the narrative in the interests of fewer and fewer people. (Think Bernie Sanders, Hillary Clinton, Donald Trump, here in NZ the axing of John Campbell from evening television & meteoric rise of Mike Hosking. The completely neoliberal main stream media represented by the Herald, the replacement of investigative journalism with USA style infotainment.)
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