The great strength of capitalism is also its failure... the inventiveness and ambition of bright people. John D. Rockefeller and Andrew Carnegie were not bad people, they were very smart. But regulation was needed to control their monopolies (the Sherman and Clayton Acts in the late 18th and early 19th centuries). The right to compete, a fundamental component of capitalism, was being eroded because of unregulated monopolistic corporations linked by trusts. The monopolistic capitalists got too clever and too big.
Likewise, the risk-taking and freewheeling traders and stock speculators in the '20s learned to make fortunes (albeit ephemeral), by making outrageously leveraged trades on the margin. Eventually, we forgot the lessons we learned in the 20s and loosened the controls that were essential to prevent a system-wide meltdown. We forgot the lessons of excess leverage and weakened safeguards. The safeguards we kept were poorly implemented. In the 1980s and 1990s the fed shifted from Keynesian fiscal control of the money supply to Chicago-School monetary control of the money supply. I admit that I thought that Greenspan was doing a remarkable job keeping our economy on an even keel with his manipulation of interest rates. I didn't recognize the extent of the danger from the easy credit and the excessively leveraged derivative trading. We screwed up on a couple of major fronts... loosening or abandoning essential regulations, and badly using the regulatory power we had. Like it or not, unregulated laissez-faire capitalism is doomed to damage itself without regulation. There are simply too many bright and ambitious people out there who will find out ways to exploit legal schemes to make gobs of money. With good regulation, these people will continue to make gobs of money in clever ways, but they will do it in a way that won't cause periodic system wide meltdowns. Chris _____ From: [email protected] [mailto:[email protected]] On Behalf Of Dr. Ernie Prabhakar Sent: Tuesday, May 19, 2009 10:30 AM To: Radical Centrist Discussions Subject: [RC] A Failure of Capitalism (II)--Whom to Blame? - Richard A.Posner A useful analysis. While this could be read as blaming the government for everything, the implication is that the industry *needs* the government to regulate it appropriately, as otherwise the market incentive always ends up leading to taking on excessive risk... -- Ernie P. http://correspondents.theatlantic.com/richard_posner/2009/05/a_failure_of_ca pitalism_ii--whom_to_blame--richard_a_posner.php In fact the bankers took too many risks from an overall economic standpoint, and that is the immediate cause of the economic hole we're in. They made too many risky loans, especially in real estate, and when the risks materialized the banks' assets, which included many real estate mortgages and securities backed by such mortgages, plunged in value. The banks found themselves undercapitalized and reduced their lending, which slowed economic activity, which began the downward spiral that we're in. They were permitted and indeed encouraged to take risks that were too great from the standpoint of economic stability by the government itself, in two major respects. First, the regulatory controls that had once limited the amount of risk that banks could take, in recognition of the potentially catastrophic effects on economic stability of a collapse or near collapse of the banking industry, were gradually dismantled, beginning in the 1970s. Not completely dismantled, but enough dismantled to allow competition almost free rein to push the bankers toward taking more risks than were good for the nation's economic welfare. And second, the Federal Reserve pushed interest rates too far down at the end of 2000 and kept them there longer than made economic sense. The results included a housing bubble, a credit bubble, the bursting of the bubbles, and the ensuing swoon of the banking industry--all of which I'll explain in the next blog in this series.
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