How a Deficit in Capitalism Helped Engender the Financial Crisis

The Financial Times continues its series on “Capitalism in Crisis.” We’re getting a little tired of it. We were hoping at least one of the writers might tell us what the crisis was. Instead, we’ve gotten a variety of opinions; none offering much light on the nature of the crisis and several offering more darkness about how to make it worse.

In yesterday’s installment, for example, we discover that in 2008, “leaders of rich and rising nations sidestepped their differences to avert a worldwide slump.”

Really? If the writer had any appreciation for capitalism at all he’d know that the politicians did no such thing. Instead, they sidestepped their differences to prevent capitalism from doing its job. In 2008, after the fall of the House of Lehman, capitalism was aiming its wrecking balls at the House of BAC, the House of Deutschebank, the House of Goldman…and many others. But the feds stepped in and stopped the wrecking balls in mid-air. The process of price discovery halted.

Instead of allowing capitalism to fix the problem, the feds made it worse. They gave more money to the very institutions and managers who had proved they couldn’t be trusted with it.

We don’t want to rehearse the whole sequence of events that got us to where we are. But it’s important to understand what happened.

The FT writers — along with practically every financial journalist, economist and 2-bit big mouth — get the whole story wrong. They seem to think that Lehman Bros. was a failure of capitalism. Symptomatic, they say, of a larger failure, which almost all believe came from a lack of effective regulation.

“Too much capitalism…” is how one sage put it.

“The big lesson from all this is the extent to which globalized capitalism has outstripped the ability of governments to manage it,” says the FT.

Manage it? They must be dreaming. If the guys who ran Lehman Bros. couldn’t manage their own business, how were a group of bureaucrats going to do so? On the evidence, the feds had even less idea of what was going on than the ‘capitalists’ themselves. (About which, more below…)

The real problem was not too much capitalism. Instead, there was too little, especially when we needed it in 2008. The financial industry had been corrupted by government. Federal subsidies to the homebuilding industry…along with artificially low interest rates from the Fed…created a bubble in the economy and a frenzy on Wall Street. The financial industry became obsessed with fast profits. Bank managers learned that they could earn fees by making loans; who cared about collecting them?

Also, most Wall Street firms had ceased to be genuinely capitalistic. The benefits and the control were no longer in the hands of real capitalists, but in the hands of the managers. Over the last ten years, for example, the owners of financial industry stocks have made zero. Not a penny. But the managers — employees — have gotten rich. Goldman Sachs alone transferred $125 billion of shareholders’ money to its labor force over the same period that the shareholders themselves made nothing.

This left the employees with nice pads in the Hamptons, but it left the shareholders will little in real value. Today, many major banks have equity of less than 2% of their assets. That means, if their holdings of government debt — for example — go down 2%, they are broke. And it leaves them vulnerable to the next crisis….just as they were to the last. When the crisis came in 2008, there was not enough equity — real shareholder value — to prevent bankruptcy.

This was not a crisis of real capitalism. It was a problem of geriatric capitalism…a simple problem that real capitalism knew how to fix. Left to do its work, these banks would have gone out of business…as they should have.

Collapsing banks would have meant the collapse of many other things too. Greek debt, for example. The banks’ holdings would have been subject to fire-sale prices…driving down their own prices…and putting Greece and other major debtors into bankruptcy too.

This, of course, is just what the feds wanted to avoid. Today, more than 3 years later, they’re still trying to avoid it. That’s the drama we follow in Europe almost every day.

But far from illustrating ‘capitalism in crisis,’ it shows the crisis caused by the fixers themselves. Now they’ve got banks that would be bankrupt…if Mr. Market were allowed to fully express himself. The bankrupt banks are kept in business by governments, who should be bankrupt too.

And since Mr. Market is sidelined…he can’t solve the real problem. The bankrupt institutions stay in business…shifting more and more real resources to zombie institutions run by incompetent, but highly paid, managers.

This leaves the illusion of repairing things to the managers themselves and their fixer friends in government.

The FT gives a claptrap solution:

“…extend and refurbish the multilateral order to make economic integration with great global governance.”

We’re not sure what that means. But we know it is a mistake.

People may not know what capitalism is, but they know they don’t like it. A poll by Globescan found that support for capitalism has fallen by 20 percentage points in the last ten years. A few years ago too, Mitt Romney’s success at Bain Capital would have been a plus on the campaign trail. Now it is something he needs to explain and defend.

The poll found higher levels of support for capitalism in China, Brazil and Germany too.

Here is Qin Xiao, a businessman from China who has experienced state planning in a direct and personal way. In the 1960s, he was exiled to the countryside of Inner Mongolia to be “re-educated.” The purpose of the re-education was to help him learn that “government was the savior of the poor and free enterprise was evil.”

Instead, what he learned…and observed since…was that the free enterprise system works. A planned economy doesn’t. His advice to China:

“An economy now dominated by the government needs to become one led by the market…the government must scrap procedures for approving economic and market activities…it must stop interfering with market prices and transactions…”

What gives? Are these emerging market thinkers naïve?

Nope. We don’t think so. Here at The Daily Reckoning, we expected them to be pro-free market. Why? Because people are neither bad nor good, smart nor stupid. They are subject to influence.

They will favor market systems when market systems are making them rich.

US capitalism — fettered by zombies…managed by incompetents… regulated by bureaucrats — no longer makes people rich. It has cut the real hourly wage of a non-high school grad by 47% over the last 32 years. No wonder Americans don’t like it.

In the emerging world, on the other hand, real wages double every ten years or so. They like capitalism. They want to practice it.

Bill Bonner
for The Daily Reckoning