Credit crisis, capitalism and the human condition
by Kathleen Lucia, EAU Vice-President

Fallout from the global credit crisis will be a long time settling through what many fear will be a deep global recession; even depression. Already many millions of words have been written about the causes, consequences and implications of this trauma. Among the most popular predictions is the end of “free market” Capitalism as we know it and a return to state managed economies as we used to know them in the two decades following the second world war. Would this be a return to good sense, fair play and social cohesion or simply more shackling of human invention and enterprise?

There are no prizes for guessing the position of veteran Marxist historian, Eric Hobsbawm. He believes that free markets always result in instability. He argues that globalization, which is implicit in capitalism, not only destroys cultural heritage and tradition, (by implication the things that really make people feel happy and secure) but it is also highly unstable, operating through a series of crises. “I think this (time of crisis) has been recognized to be the end of this particular era," he told an interviewer for the UK’s state broadcasting service. Hobsbawm says: “The present ultra-free market phase of capitalism has been in crisis for some time, but until today this was not evident in the advanced western economies. It is now clearly the most serious crisis of the capitalist system since 1929-33.

“There is nothing individuals can do except push governments to ditch their belief that the way profit-maximising business works is a model for state and society. Government action protects us and, as is now clear, will have to keep even a free market economy going in the new phase of the economic system that we are entering. But I suspect it will take a few years before the capitalist world economy, in its new phase, will find a new formula for stable growth”.

In the wake of the banking collapses of early October, the UK’s BBC (British Broadcasting Corporation) canvassed the views of a number of prominent thinkers on the future of capitalism. In general agreement with Hobsbawm was Tony Benn, former UK government minister, who declared: “This economic crisis is a global crisis, it is more serious than the crisis of 1929. There will be a big demand for a major policy change. This is a failure of a system where we relied on the markets and excluded government. And the markets failed”.

But are we really seeing a collapse of capitalism signalled by a failure of ‘free’ markets? Have we really succeeded in excluding government? How ‘free’ are our free markets and how does making them less free really improve our lot?

One the BBC’s selected talking heads, prominent trades unionist, Brendan Barber, makes the point that there are various market approaches, and  concedes: “This is not the final crisis of capitalism, but it ought to be the end of the road for a particular version of it. The truth is that there is no single economic model of capitalism. There has always been a considerable difference between Europe’s social market and the Anglo-Saxon version in the US – not to mention the wild-west excesses of post-communist Russia or the strange hybrid that now operates in China. What we have seen should rather be the last gasp of the belief that the way to secure prosperity is to let free markets rip and tear up any regulation that gets in the way of short-term profit. Already the view that the state has no role to play has gone with the nationalisation of Freddie, Fannie and AIG in the US and Northern Rock in the UK”.

But have our great and good ever let free markets “rip” or taken the view that the state has no role to play? It takes relatively little reading, discussion and observation to come to the view that that at no time have markets been truly free in the sense that individuals could, within a commonly accepted framework of law, make business transactions free of any interference from powerful governing elites. Governing elites have always considered it their right to take a share of any trade and business profits through taxation, intimidation or both. Interference of all or any kind distorts markets and renders them unfree. Free markets, perfectly possible in theory have never actually been tried.

Socialized cost, privatized profit
Admittedly, outside interference is probably not the only cause of market problems. Noam Chomsky, linguist and political theorist, points to what he sees as another inherent problem associated with Adam Smith’s “invisible hand”: that the market comprises countless individuals pursuing their own interests, not necessarily with regard to the effect of that pursuit on others. He argues that markets fail to calculate the costs of transactions to those who do not participate in them. Financial institutions, particularly, he says, take risks while calculating potential costs only for themselves, not an economy as a whole. “Hence the financial market underprices risk and is systematically inefficient”. But is the state – the governing elite – any more efficient? Chomsky certainly does not make it sound any more laudable.

He goes on to say: “The unprecedented intervention of the Fed may be justified or not in narrow terms, but it reveals, once again, the profoundly undemocratic character of state capitalist institutions, designed in large measure to socialise cost and risk and privatize profit, without a public voice...The advanced economy as a whole relies heavily on the dynamic state sector, with much the same consequences with regard to risk, cost, profit and decisions, crucial features of the economy and political system”.  So the choice, then, is between individuals freely doing business with others, but without regard to those who are not doing business – or the state doing business, purportedly on everyone’s behalf, but seriously disadvantaging many in the process. As the economist Ludwig Von Mises is reputed to have said: “Government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it”.

Peter Jay, economist and Bank of England non-executive director, rather reluctantly gets to the real nub of the issue: that what we refer to as capitalism is, fundamentally, the human condition. He says: “We had grown cynical of Marxist talk of the contradictions of capitalism because Marxism itself had, by the 1970s so conspicuously failed – while capitalism thrived – that its acolytes were discredited...But now we must face the real possibility that the mood swings of financial markets cannot, forever, be biased to optimism; that the higher they climb, the harder they will eventually fall and that this flaw in capitalism cannot be fixed – even by Alan Greenspan – because it is embedded in unchanging human psychology”. Free market behaviour is the default position of humankind.

Darwinian extinction of caution
But probably the pithiest analysis of this year’s crisis comes from a far less feted commentator, too obscure to be turned to by the BBC for his wisdom. Paul Tustain, director of a specialist gold trading company and, thereby, intimate with the workings of markets has no doubt that the problem has its roots not in markets, or in human nature, but in the management of the financial system by politicians.

For 10 years, in the UK Prime Minister and former Chancellor Gordon Brown and in the US former Federal Reserve Chairman Alan Greenspan, kept interest rates unusually low to stimulate investment and demand, which Tustain describes as “a near-sighted economist’s way of avoiding mild recessions”. This he argues “leads directly to a world of crazy finance, because low rates punish caution...Why would anyone pay more for funds from a cautious bank when cheaper funds from an easier source are available? This is why the profits of incautious banks grew and why their stock prices multiplied. Meanwhile, careful bankers sunk....This Darwinian extinction of caution is the direct result of a monetary environment which was hostile to cautious bankers; one which favoured those banks with an appetite for cheap money.”

Tustain gives an equally succinct and direct reason to fear government intervention and regulation: “If we allow government to control finance through regulation we give extraordinary power over the direction of the economy, because they can (and will) deny finance to some projects and grant it to other, more politically appropriate ones. They have repeatedly shown themselves to be much worse than our imperfect marketplace at handling the power of economic direction, both in this case, where their efforts at economic stimulation are the root cause of the fiasco, as well as in recent history, particularly with Communism”.

Unintended consequences
Yet it seems that calls for more and “better” regulation will be irresistible, however strong rational argument to the contrary. The consensus view is that there will be heavier regulation of financial markets given the propensity for the rich world’s governments to seek the regulation of just about every aspect of their citizens’ socio-economic lives. But regulation seems always to trigger the law of unintended consequences. These usually include cleverer folk than government officials finding a way around the rules, as intelligent, innovative human animals will, not only in financial services but all sectors of commerce and industry.

The prominent economist Professor Patrick Minford, of Cardiff University in the UK, observes: “In all the current financial train wreck, voices are already being raised to demand huge increases in regulation and the “curbing of capitalist excess”. It needs to be remembered firstly that, already, massive regulation is in place across banking practices under the Basle Agreements. The trouble has been that the banks avoided them by using “special investment vehicles” away from their balance sheets”.

He might have added to the presence of Basle the thicket of other international financial services regulation that has grown up since the turn of the century, including IFRS (International Financial Reporting Standards) and in Europe MiFID (Markets in Financial Instruments Directive) all aimed at achieving the sort of transparency of transactions that would prevent exactly the sort of crisis we have seen.

Then there is the Sarbanes Oxley legislation introduced in the US in the wake of the Enron scandal, which famously makes top executives personally responsible for the veracity of company accounts and which is equally binding on all foreign companies that wish to have a US stock market listing. (The NYSE has, of course suffered a marked contraction). It is reasonable to say that at no time has there been such a profusion of far reaching and hideously richly detailed regulation. Some might say that the wonder is how bankers, insurers and investment managers continue in profitable business at all.

As Minford says: “Capitalism has a good record of dramatically raising the world’s living standards over long periods of time. ...we need a vigorous and competitive banking and financial system – this is vital for growth and the availability of financial flexibility across all parts of society. Any adjustments to the existing regulatory framework must keep this firmly in mind”.

Dr. Jon Danielsson, member of the London School of Economics financial markets group, adds: “We hear that the wave of mergers, nationalizations and bankruptcies in the financial world represents the failure of the old way of doing business: that the future of finance is a heavily regulated, 1950s-type world. Nothing could be farther from the truth. The costs of preventing crises mean an economy like Cuba’s and North Korea’s.

“While some banks, with acquiescence of banking regulators and often with the full support of governments, did get into serious trouble, it is reaction to the crisis that really matters... The real tragedy would be if the official reaction to this crisis were ill thought, politically motivated, overbearing regulations.”

An optimist might say that while regulators are sharpening their pencils, the regulated will be sharpening their wits.