Is Capitalism in Crisis? Becker

 

Capitalism in Crisis is the title of a long series of articles in the Financial Times by many participants. No doubt, the severity of the Great Recession has temporarily weakened the respect for capitalism, for “free” markets, and among other things, for the Chicago school of economics. Yet I will argue that the FT’s title should have had a question mark, as in: Is capitalism in crisis? My answer is that while certain aspects of the economic organization of capitalist countries like the United States should be changed to reduce the chances of future severe recessions, it remains true that economies which are competitive and capitalistic have the best prospects for sizable long-run economic growth.

The Great Recession reinforced the lesson of prior panics and financial crises, lessons forgotten during the Great Moderation from about mid 1980s to 2006, that the financial sector has a fundamental built-in instability. In the past this was mainly associated with “runs” on banks, as during the Great Depression of the 1930’s. The instability of modern financial institutions is no longer much related to bank runs because of deposit insurance; rather it is mainly the result of the incentive for financial institutions to raise their profits by increasing their assets relative to their capital.

One straightforward way to reduce this instability is to raise capital requirements of banks and other financial institutions. Greater capital would provide banks with bigger cushions if the value of their assets fell as a result of a crisis in asset markets. Any mandated capital/asset ratio should be greater for banks that are considered too big to fail than for other banks in order to make it less likely that larger banks would need a bailout. The United States and Europe have already moved to increase capital requirements for banks. These rules will have to be adapted over time as banks discover ways to mitigate the impact on their lending.

Asset price bubbles are another issue to deal with. The collapse of the “bubble” in Internet companies in the US during the late 1990s did not have a major impact on the US economy because it affected only a small part of total assets. Similarly, the many bubbles in local housing markets in the past, such as the Florida land boom of the 1920s, greatly affected these local markets, but did not have much affect on the US economy because they were not important to the overall economy. However, unlike these previous local housing booms, the boom from 2002-07 was national, although clearly stronger in certain regions, like Las Vegas, than in other regions. The collapse of this boom had a big enough impact on consumer and bank assets that it did seriously affect the US economy.

The boom in housing prices was related to the low interest rates after the early 1990s, and also to the growing number of mortgages that required neither much of a down payment nor decent credit histories. To reduce the likelihood of such housing bubbles in the future, it might be wise to require larger down payments to get mortgages, so that mortgage owners would have more “skin in the game”. Of course, politicians would likely oppose higher down payments because younger and other households with limited capital would find it harder to buy homes.

While vast attention has been given to the failures of capitalism after the financial crisis erupted, government “failures” that contributed to and prolonged the crisis have received much less attention. Yet government failures were numerous and important. These failures include the Fed’s decision to keep interest rates low after 2003 even though asset markets were booming, and the many bank regulators and other government officials who cheered on the expansion of bank assets rather than trying to control assets/capital ratios of banks. Government failures also include the congressmen and other government officials who encouraged, and even required, banks to offer mortgages to households with bad credit histories, and to households who could provide only a small amount of equity in their homes. Not the least of government failures are the many state and local governments, and countries like Greece, Ireland, and Portugal, that took advantage of the good times preceding the crisis to increase greatly government spending and debt beyond reasonable levels.

It is because of government regulatory failures that I believe the best hope for preventing banks and households from excessively expanding their debt in the future lies in rules, like capital requirements, rather than in greater discretionary power to regulators. Regulators misuse discretionary authority because they often get caught up in the same euphoria that banks and households succumb to. In addition, they sometimes get “captured” by the banks and households they are regulating, and end up being cheerleaders for these sectors.

Yet the fact that financial and housing markets did “fail” in the years leading up to the financial crisis (although their failure was partly induced by bad government policies and poor regulatory oversight) does not add up to a crisis in capitalism as a whole. The vast majority of competitive markets in a capitalist economy like that of the United States performed quite well both before and during the crisis.

China’s form of state capitalism is often considered to be a good alternative to competitive capitalism. China has had an astounding economic record during the past 30 years, but the private sector has been the most productive and dynamic part of its economy. China’s growth started when in the late 1970s it opened farming to the private sector. China has steadily increased the share of output produced by the private sector. Public enterprises are still important, but China has grown despite the important of state-owned enterprises, not because of it.

Capitalism lost prestige as a result of the severity of the Great Recession, but so too did governments. I do not believe that capitalism is in a real crisis, partly because the defects in financial and housing markets can be corrected to a significant extent. More importantly, reliance on competitive capitalism has been the only way that countries have been able to reduce poverty and continue to grow over long periods of time. The great majority of developing and other countries will not forget this fundamental reality as the world pulls out of the Great Recession.

 

 

Comments

[TANSTAAFL]

"[R]eliance on competitive capitalism has been the only way that countries have been able to reduce poverty and continue to grow over long periods of time." Quite true. As Posner points out below, however, the politics of envy threatens competitive capitalism.

[Mitchell K.]

Becker believes that the title ("Capitalism in Crisis") used by the Financial Times should be followed by a question mark. The title "Welfare States in Crisis?" might be just as sound.

This recession has certainly wounded American optimism and undermined confidence for the financial sector and capitalism in general. The housing market crash and the ensuing financial crisis continue to reverberate, but the United States is in a stronger position for recovery than the welfare states of Europe. American debt is massive but so is American output. The economies of Europe, on the other hand, are more stagnant and government spending is heavier.

The recession has made austerity an imperative in nations like Greece, Italy, and Spain. Proposed reductions in government spending have been met with widespread social unrest and rioting whereas the Occupy Wall Street movement in the United States has been a mere blip by comparison.

[juandos]

The other side of this coin of capitalism supposedly in crisis should read (IMHO), "is this what we taxpayers get for the money that's obviously wasted on public education?"...

[security management service]

I would agree with the other side aswell, great work

[burberry outlet]

I would agree with the other side aswell, great work

[online colleges]

Capitalism is an economic system that became dominant in the western side of the world. i would also agree with juandos.

[Ed]

Unfortunately, what we can see in western Europe and US has nothing to do with capitalism. Among other deformations, huge amount of activities which are in capitalism performed by entrepreneurs are carried out by governments. If we ask "is capitalism in crisis" in this situation, this question is meaningless.

[property inventories in London]

Of course, that it is. Big players and politicians wants more and more. Don`t care that much about the people. The connection is lost.

[nelsonlevi]

The road to recovery cannot be simply about returning to modified free-market capitalism and a re-established, utterly bankrupt consumer society.

[Vuk]

but what happens if you increase the capital requirements in the current situation? Isn't this likely to get the banks to lower their lending levels? They react by placing their funds overnight with the central banks, meaning they would rather accept a small loss (they took a loan with a central bank with a 1% interest, while holding it overnight yields a 0.5% interest) than to lend to anyone with even the slightest possibility of being risky.
It is understandable why they are acting this way - they simply don't want to risk anymore public anger against them. As a result, lending is stiff, and the economy is still not fully recovering.
Constraining them with higher capital-asset ratios is likely to further this uncertainty within the banks.
Perhaps this would be a better solution in favorable times, but currently, I don't believe it would do any good.

[Jack]

For now:

Becker mentions the lack of lending standards, overlooks the utter corruption of the four major bond raters whose criminality allowed the sales of KNOWN toxic piles of junk but alights on:

"To reduce the likelihood of such housing bubbles in the future, it might be wise to require larger down payments to get mortgages, so that mortgage owners would have more “skin in the game”."

........ We did just fine with low down payment home programs, and perhaps NO down VA one of the lowest of loss ratios, but what we HAD was banking standards and without the loans being sold downriver BANKERS having "skin in the game" instead of a fast buck commish.

"Of course, politicians would likely oppose higher down payments because younger and other households with limited capital would find it harder to buy homes."

......... so would economists who were aware of how low and stagnant are the wages of most and especially the young, would be, household formation cohort.

THE question now is what to do with the over-sized homes of the "move up" "boomer aged" folk as they retire and no longer need nor can afford the upkeep on them while those of the younger set, mired in unemployment and even worse wages can not afford to buy them.

In a recently released book "Going Solo" the author insightfully describes over half of our population no longer living as Mom Dad and the Kids with many for a variety of reasons opting to live "solo". I suppose that points to many non-traditional households (the Golden Girls?) but these combos are not likely to sop up many of the excess "praire mansions".

Better to have as many as possible in the hands of buyers eligible for documented loans, regardless of down payments. Even a higher than desirable loss ratio is better than having them on the bank's R/E owned list that requires guards and maintenance crews.

[Jack]

Tannstaff: What you term the "politics of envy" are more truthfully described as the "politics of pragmatists" who understand that no engine can last when all the oil is pumped to up into the valve covers leaving the lower end unlubricated with bearing failure predictable.

As for "capitalism in crisis" skipping, for now whether the market distorting favors dealt out leaves us with a "capitalism" whatever we do have in INDEED in severe crisis.

Skip all the other indexes and just jump to the fact of their being No shortages, and a similar GDP being generated while 20% of our work force is either under or unemployed with the average having been out of work for about a full year. Then glance over at the pickiness of those with a few jobs to offer: "Go home, apply online" with the online app often telling the prospective applicant that if they are unemployed, do not bother to apply.

Economic gridlock: The rich sit by the fire in their Long Island compounds, saving their top 2% wages after having purchased all they need for a lifetime, while the other 98% plod on with long stagnant wages (or NO wages) and have too few discretionary dollars to turn their needs and wants into the DEMAND, the lack of which continues to drag down what's left of our economy and the market for much of the rest of the world's exports.

[Mr Feel Good]

obvious it is..it s damn crisis.................

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[Kassandra]

There might still be a good solution for that right? All the leaders just need to do that right thing.

[TANSTAAFL]

Your views are well considered and oft repeated, Jack. Unable to prevail against the "rich [who] sit by the fire in their Long Island compounds" on the basis of merit, you would prefer to compete at the ballot box, casting your vote for politicians who will wrest from such Long Islanders their property and redistribute it to you and your kind, free of charge.

Well, maybe not free of charge. Voting for coercive wealth redistribution mortgages our American birthright and casts a pall on generations to come.

[stubman]

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[ティンバーランド 靴]

great work

[Jack]

Tans -- Thanks, however, I've also repeatedly taught that the redistribution began 40 years ago with a complete rout in favor of the top 1% with the top .1% out doing even them.

Have taken a few minutes to study my oft posted graphs clearly depicting the economy tanking trend?

http://lanekenworthy.net/2008/03/09/the-best-inequality-graph/

Is it true of those of your views that it's only those tending towards laziness at the topmost tiers who require obscene levels of "performance bonuses" in order to answer their alarms? while those of the long stagnant wages are expected to do their very best as they endure the loss of purchasing power?

What do you suppose happened, during and since the Reagan/Gecko era that required "compensating" CEO's and upper level gleaners at over 400 times working folk's "compensation" when in an earlier time we got a fairly honest and hard working bunch for a, still high by world standards, 30 times the wages of their team players?

BTW in terms of polling and voting, just a few years ago when working folks had a little bit for themselves only 20% were mindful of being overly fleeced from the topmost tiers, but now that the former middle class has lost home equity, learned how, predictably, the 401 retirement scheme can bite, taken a pay cut and lost one of the earners of the family some sixty percent are now aware and a bit irate after learning of the effects of thirty plus years of The All for The Rich trend and agenda.

Did you know that had we maintained the wage disparity (GINI) curve of the era when JFK, perhaps idealistically (naively?) hoped the rising tide of productivity would "lift all of the boats" that most middle class households would have $10,000 more income? with those nearer the bottom $5 - $7,000 more?

Now consider what effect that would have on an economy such as ours that is 70% dependent on consumer spending? Just think..... the bills all paid, and nearly $1,000/month with which to "go shopping" or possibly put a bit by for a, someday? retirement?

Possibly....... that explains a recent poll tallying some 20% of Repubs planning to vote for the incumbent, although given the flaws of those produced by the GOP process, in fairness, it may well be that the see the reform minded President only as the least worst of the few choices offered.

And lastly? and ONLY IF you took advantage of the graphs presented..... how much longer do you think the trend of graph one, or even that of graph two can be sustained? My own observation is that the bones of the "98%" have been pecked pretty clean with not much belt tightening in order to further fatten those of the "owner/scammer" class. Do you think it can be "worked" for another year or two?

[cindy]

I really think so! I am so happy to discuss it with you!

[Jack Walton]

If it weren't for the Florida land boom of the 1920's, however, we wouldn't have had the first Marx Brother's talkie: "Cocoanuts". Thanks for the article!

Government intervention: we have rule FD which has reduced disclosure, we have SarbOx which has eliminated small companies from accessing the public capital markets, and of course we had the GSE's in the mortgage market which has rendered the housing market a "Slough of Despond".

and now we turn to the Volcker rule -- and dealer inventories of corporates are dwindling even before it's enacted. we've a bubble in the low end of the i.g. corporate credit market as risk isn't being priced correctly.

[Fabian]

"One straightforward way to reduce this instability is to raise capital requirements of banks and other financial institutions. Greater capital would provide banks with bigger cushions if the value of their assets fell as a result of a crisis in asset markets."

But what do you think of the potentially disruptive behavior of a global market for CoCos (Contingent Convertibles), perhaps comparable to that of CDOs? How would responsibility be taken for unintended negative externalities? Discussions on the right way to cope with instability should focus also the way financial innovation is conducted, governed and made accountable. A number of industry participants to the 2011 Paris Conference "Debating Responsible Innovation in Finance" raised that issue. See: http://www.debatinginnovation.org/blog/?p=103

[Paul Smith]

Merci beaucoup pour votre article.

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[Jack]

Calls such as "more capital requirements" remind me that capitalism is but a tool and one that must be directed by a functioning government.

Thus..... the question of capitalism in crisis comes back to government being in serious crisis.