Sunday, January 29, 2012

The Fall of Communism made the West overconfident in unfettered Capitalism

Reading an interview of novelist Robert Harris, who wrote a novel about the forces that crashed the financial markets, "The Fear Index", provided one of the most succinct summaries of what happened that I have come across:

As the years go by, we begin to see the shape of the last 30 years or so. The fall of the Berlin Wall was a terrific boost to belief in the free market—a lot of regulations were lifted, and there was a kind of hubris about what the markets could do…This era collided with the digitalization revolution, and it does seem to me that the financial markets slipped out of control—of government control and, to some degree, almost of human control.” 

This makes a lot of sense to me - that it was an overconfidence in the power of unfettered free markets that led to the cognitive capture of politicians, regulators, ratings agencies, the financial industry itself, and last but certainly not least, homeowners and wannabe homeowners.  That overconfidence led to reckless and risky behavior that ended catastrophically.  And that overconfidence was a function of the triumph of Capitalism over Communism.

There was certainly a crisis of greed, but it was a greed that was the madness fueled by the kind of irrational enthusiasm first exposed in the great tulip mania in 1600s.  Wikipedia notes:

"At the peak of tulip mania, in February 1637, some single tulip bulbs sold for more than 10 times the annual income of a skilled craftsman."

This, of course, was a bubble that burst, to the detriment of many.

I believe that what happened is that the financial industry figured out the same thing that the government figured out long ago - where the money is.  And where the money is is in the middle classes. 

When government needs money it raises taxes.  Some seem to think that taxing the two or three hundred thousand people who make a million dollars or more raises a lot of money, and it does, but not nearly as much as taxing the vast scores of millions of people in the middle classes.  

In the same way, the financial industry discovered that they could transfer billions of dollars to themselves from middle class homeowners and those who could be convinced that they must become homeowners or they would be left behind.  So, the financial industry fed the housing bubble with ever riskier and unsound mortgages.  But, more importantly, they spread the belief that the markets would make us all a lot of money.  Many of them certainly did make themselves unbelievably wealthy.  

I am mindful of what Warren Buffet said in 2008 when on a discussion panel about how the financial industry could clean up the mess that it caused.  He said that we had to remember who these people were:  they weren't in their industry to benefit the world, they were in their industry to make money, and that is all.  Making money is important to most people, but having and making money be the only goal leads to things like the near collapse of the financial markets and the world economy by people, many of whom to this day feel no guilt nor regret about what they did and who they are.  Their measuring sticks for their value is their how much money they make and have, and how they contribute to society is simply not on their screens.  Strange indeed.

However, millions in the middle classes lost their livelihoods and lost their homes.  Unfortunately, the story is still playing itself out.  False beliefs are terrifying things, they can lead very large percentages of people down false paths following destructive hopes, and they can cause a great deal of pain and destruction.

The fall of the Soviet Union and the exposure of the failure of Communism really didn't mean that Capitalism was some kind of infallible wealth creating system.  Some of the faithful, true believers in unfettered capitalism have yet to learn that lesson, and that is unfortunate.  

Perhaps this election can help clarify the distinction between the fatal flaws of unfettered capitalism which quickly devolves into exploitive distortions of the markets, and the power of a well regulated economic market that creates the space for the power of capitalism to do its magic and create wealth and benefit society - especially the middle classes.