Or - what went so very wrong with "risk and reward?"
For a long time, I have been confounded by those who are so against capitalism. To me, capitalism and free markets embody so much of what is great about our nation. We are not a country where elites and/or royalty have all the power, with no one else able to get into a tiny, controlling circle. Our nation is one of millions of rags-to-riches stories: a poor black child who became one of the most influential and wealth media names - Oprah Winfrey. A Jewish-Russian immigrant who transformed the Internet and became a multi-billionaire; think Sergey Brin. While these two individuals are extreme examples, there are literally millions of people who came from humble beginnings and rose either to upper-middle class status or wealth because of the opportunities here... essentially because of free markets and capitalism.
So - why is it, when we have a system that allows most to rise as high as they wish, that more than a few are so critical of our system? Over and over, this has confounded me. Yet, the more I read and study, the more I think I see why those who rail against free markets are doing so.
It's not because the underlying principles have altered. A free market, with all its flaws, is superior to everything else. Nevertheless, the "free market" works only if it is indeed free. That is, the principle of "risk and reward" must remain. And - that underlying principle in recent decades has been badly damaged.
One of my favorite blogs is Cafe Hayek, written by economists Russ Roberts and Don Boudreaux. Each takes complex principles, policies, philosophies and hard data, then explains it in ways that even a doofus like myself can understand.
To really explain the housing boom and bust followed by the financial crisis, you need an explanation of why Fannie and Freddie AND the investment banks were so reckless. The Pinto/Wallison explanation is that Fannie and Freddie were reckless because the government made them do it. The left’s explanation is that the investment banks were reckless because the govnernment let them do it. Both left and right ignore the role of the other part of the market. But more importantly, both the left and the right leave unexplained how the reckless risktakers–the GSE’s and the investment banks–were able to do it–how they all were able to borrow money at relatively low rates despite ridiculous levels of leverage. How were they able to borrow all that money at so low rates when leverage meant high risk for the lenders?
My answer is that they were all GSE’s, all government sponsored enterprises–Fannie and Freddie and Bear and Citi and Goldman and Lehman and on and on. They all had an implicit guarantee from the government that allowed them to borrow at low rates (often from each other), rates that were well below market because of the implicit guarantee. And they were able to borrow at low rates even though they were highly leveraged which made them vulnerable to defaulting on their debt. Despite that vulnerability, they were still able to borrow at low rates. When things fell apart, almost all the creditors, lenders, and bondholders got all their money back, 100 cents on the dollar. The only exception was Lehman. The rest were all taken care of despite funding really bad bets.
People can call something a free market, if they so choose. But, that doesn't make it so. You need both parts of the equation for it to function as a true free market. People must have the freedom to be able to take on risk. If the risk they accept works to their advantage - they reap reward. Yet, if their choice ends in failure, then they must live with the consequences of that failure. Having government step in and rescue people from choices that turn out poorly is not a free market or capitalism; it's a rigged system.
As Roberts goes on to say:
Almost everyone made money from
this deal except the group left holding the bag—the
taxpayers. There is an old saying in poker: If you
don’t know who the sucker is at the table, it’s probably
you. We are the suckers. And most of us didn’t
even know we were sitting at the table.
Many people have placed the current mess at the
doorstep of capitalism. But Milton Friedman liked
to point out that capitalism is a profit and loss system.
The profits encourage risk-taking. The losses
encourage prudence. Government policies have
made too many markets one-sided. Because of
implicit government guarantees, the gains were private
and the losses were public. The policies allowed
people to gamble with other people’s money, and by
rescuing the creditors of Fannie Mae, Freddie Mac,
Bear Stearns, AIG, Merrill Lynch, and others, policy
makers have further weakened the natural restraints
of the profit and loss system. This isn’t capitalism—it
is crony capitalism.
Here is my New Year's wish to all. May 2012 be a year when we no longer stick our heads in the ground and ignore reality. May it be a year when we enjoy all that is new and wonderful - but also return to principles and wisdom of the past that too many have forgotten. May your joys be many and excellent - and may your sadness be just enough to appreciate that which is wondrous.