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The Most Redeeming Feature of Capitalism is Failure

Summary:
Capitalism is under attack by utopians who wish to impose a more compassionate system and by political opportunists. Capitalism Under Attack by Two Groups Misguided utopian socialists including Bernie Sanders, an entire group of writers at The Intercept, academia, and the liberal media in general. Political Opportunists like Elizabeth Warren who ridiculously claims to be "capitalist to my bones" but who in fact is a Marxist like Jeremy Corbyn, a UK Labour politician who just went down in flames in the December UK election. Most Illinois politicians also fall in this group. It's hard to know whether to place some in group one or group two, or both. This subject came up when someone on Twitter called me a POS for proposing bankruptcy as a solution. The discussion reminded me an article I

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Capitalism is under attack by utopians who wish to impose a more compassionate system and by political opportunists.

Capitalism Under Attack by Two Groups

  1. Misguided utopian socialists including Bernie Sanders, an entire group of writers at The Intercept, academia, and the liberal media in general.
  2. Political Opportunists like Elizabeth Warren who ridiculously claims to be "capitalist to my bones" but who in fact is a Marxist like Jeremy Corbyn, a UK Labour politician who just went down in flames in the December UK election. Most Illinois politicians also fall in this group.

It's hard to know whether to place some in group one or group two, or both.

This subject came up when someone on Twitter called me a POS for proposing bankruptcy as a solution.

The discussion reminded me an article I wrote in 2009. Here are the key parts, emphasis added.

The Most Redeeming Feature of Capitalism is Failure

There is an interesting interview in Barron's with two hedge fund managers called Shorting the Economic Recovery.

Here are some interesting interview snips pertaining to capitalism and fractional reserve lending. The rest of the article is by subscription only.

PERHAPS ONE OF THE greatest failings in the run-up to the financial meltdown was a lack of perspective -- an inability by many market participants to see the big picture. Not so with Kevin Duffy and Bill Laggner, principals of the Dallas-based hedge fund Bearing Asset Management. With the help of their proprietary credit-bubble index, developed in 2004, the managers sounded early warnings on housing and credit excesses, and capitalized handsomely on their forecasts by shorting Fannie Mae, Freddie Mac, money-center banks and brokers, builders, mortgage insurers and the like.

Students of the Austrian school of economics, which espouses a free-market philosophy that ascribes business-cycle booms and busts to government meddling with interest rates, the pair is solidly in the contrarian camp, believing that the worst for the markets may be yet to come.

Barron's: You've said that perhaps the most redeeming feature of capitalism is failure. Please explain.

Duffy: Any healthy system needs a way to correct error and remove waste. Nature has extinction, the economy has loss, bankruptcy, liquidation. Interfering in this process lengthens feedback loops. Error and waste are allowed to accumulate, and you ultimately get a massive collapse.

Capitalism is primarily attacked by two groups: utopians who wish to impose a more "compassionate" system, and political capitalists who want to enjoy the fruits of success without bearing the pain of failure. They use the coercion of the state to gain privileges, at the expense of everyone else.

As a country we've become less tolerant of economic failure. The result has been a series of interventions, such as meddling in the credit markets, promoting homeownership and creating a variety of safety nets for investors. Each crisis leads to an even greater crisis. The solution is always greater doses of intervention. So the system becomes increasingly unstable. The interventionists never see the bust coming, then blame it on "capitalism."

Barron's: What would you have done differently as the credit bubble was bursting and the Fed and the Treasury were declaring that the world would come to an end without an $800 billion bailout package?

Duffy: Allow those who essentially bet wrongly to fail, instead of bailing out people with friends in high places.

Barron's: What about the argument that a financial panic would have ensued and crushed the little guy?

Duffy: The little guy actually has been crushed. The little guy is always going to be the last one in the soup line. So he will get a bone tossed to him, like cash for clunkers. But if you are Goldman Sachs or if you have got essentially the red bat-phone to Washington, D.C., you are first in line.

Laggner: There is still a multi-trillion dollar shadow banking system that FASB [the Financial Accounting Standards Board] wants to address next year. The central planners have already spent $3.15 trillion on various bailouts, credit backstops, guarantees, etc., and given approximately $17.5 trillion of government commitments, etc., while allowing many of these institutions to remain in place, with the same people running them.

Barron's: What else could have been done?

Laggner: We could have isolated the money centers and put them in temporary receivership. Then, we could have created -- with a mere $100 billion -- a thousand community banks. If you believe in fractional reserve lending [in which banks lend multiples of their deposits], something we don't support, they could have created a trillion dollars in new credit that would have flowed to small and medium-sized businesses. Those are the parts of the economy that are choking.

Barron's: What kind of financial reform would you like to see?

Laggner: We don't believe in a central bank. The idea that banks can speculate with essentially free money from the [Federal Reserve], which ultimately is the taxpayer, and that when they lose money the Fed bails them out and then passes that invoice to the taxpayer -- that whole model is broken and needs to go away.

Duffy: To get to the heart of the problem, we need to address fractional-reserve banking, which is causing the instability. We have essentially socialized deposit insurance and prevented the bank run, which used to impose discipline on this unstable system. At least it had some check on those who were acting most recklessly. Until we address the root of the problem, we are going to have a series of crises, greater responses and intervention, and more bubbles -- and the system will keep perpetuating itself.

Misguided Blaming of Capitalism

Duffy hits the nail on the head when it comes to regulation and intervention: The interventionists never see the bust coming, then blame it on "capitalism."

Intervention created Fannie Mae, Freddie Mac, and the "AAA" rating of pure junk via government sponsorship of Moody's, Fitch, and the S&P.

Furthermore, FDIC regulation designed to prevent bank failures and runs on banks did nothing of the kind. Instead, the FDIC created a false sense of security for decades, followed by a massive collapse of banks, including the largest bank failures in history.

In 2009, 140 banks failed and that number will likely be topped in 2010.

FDIC is a moral hazard as well as Ponzi scheme of immense proportion. It allows marginal banks to raise needed funds by offering above market government guaranteed CDs. Such guarantees helped fund ridiculous condo projects by Bank United, Corus Bank, and others. Indeed, many regional banks jumped on board with enormous leverage in commercial real estate.

Very few understand how destabilizing FDIC is to the banking system.

Fractional Reserve Lending Disaster

I also agree with Laggner that Fractional Reserve Lending is a bad idea.

For example, if Fannie and Freddie had to back up their mortgages 100% with bonds of matching duration instead of the mere 3% now in place, if 100% reserves were required on checking accounts, and if there was no FDIC, it is highly doubtful things would have gotten so out of hand.

Interestingly, the legislation that created Fannie and Freddie explicitly states that its securities are not backed by the government. Supposedly, the GSE's were to receive no direct government funding or backing.

Both president Bush and president Obama (as well as the treasury departments under each administration) have shown little concern for such technicalities. Increasingly presidents are of the mind "we have to destroy capitalism to save it" or as President Bush stated (and Obama practices)“I’ve abandoned free-market principles to save the free-market system.”

2020 Comments

Here we are again: Borden Makes Surprise Bankruptcy Filing

The interventionists now want to save Elsie the Cow just as they wanted government to save Fannie Mae, Lehman, and the housing market.

Elsie a Zombie, Not a Cow

Zombie firms are companies that are unable to cover debt servicing costs from current profits over an extended period.

Cheap financing is the primary cause.

The result of zombification is low productivity as noted in Rise of the Zombie Corporations: Percentage Keeps Increasing

Also note Uber's Big Problem: It's a Zombie Corporation That Can't Make Any Money

Lesson Not Learned

Ben Bernanke bemoaned his one failure, letting Lehman go bankrupt. I propose it was about the only thing he got correct. The Fed bailed out everything else.

No lesson was learned. If you prefer, financial institutions learned they will be bailed out again.

Although we are not in a recession yet, the economic illiterates already scream for more intervention. Supposedly I am a POS for not wanting to save Elsie.

The trucking industry is next on the bailout intervention list.

Moral Hazards of Intervention

But every intervention is a moral hazard that promotes more intervention. And at increasing cost.

Few blame the root cause of all these failures: Loose money, fractional reserve lending, and government interventions to promote housing, solar energy, etc.

Meanwhile, the excesses and speculation have piled up an amazing amount of tinder in search of a match.

A match will be found. Then everyone will scream for more Fed tinder to save the day.

One Reasonable Solution

There is one way to stop the madness. It starts here: Trump Nominates Gold Advocate Judy Shelton for the Fed

Mike "Mish" Shedlock

Mike Shedlock
Mike Shedlock (Mish) is a registered investment advisor representative for SitkaPacific Capital Management (http://www.sitkapacific.com/). Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.

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