Financial Crises and American Courage
April 4, 2009
Neither a man nor a crowd nor a nation can be trusted to act humanely or to think sanely under the influence of a great fear. -Bertrand Russell
The financial meltdown that has resulted in a new American Crisis has engendered a pernicious panic of confidence. Now riddled with self-doubt, we assume, without analysis, that our system is fatally flawed and thus search for new ideas and a change in approach to replace all that which has served our nation so well for most of its 233 years. At the G-20 Summit that is concluding today, we hear the general consensus that unbridled capitalism has metamorphosized into something dangerous to the modern world; that the freedom afforded the financial markets has resulted in a “toxic cocktail” that has poisoned the economies of the world and that the blunt instrument of extensive government intervention, regulation and control of such markets—a panacea that has been the norm and which is being insisted upon by the other nineteen countries—needs now to be adopted globally; that is, here in the united States.
Living as I do in the quaint New England city of Salem, Massachusetts, I am most familiar with witch hunts and witch trials, and the well-intended, albeit wholly misguided, solutions that panic regularly engenders. As Marie Curie admonished us, “Nothing in life is to be feared, it is only to be understood. Now is the time to understand more, so that we may fear less.” Thus, let us all therefore take a deep breath, gird our loins, suspend action and let reason intervene before setting in stone our future course.
First, let us ask ourselves what exactly caused this problem. Is there any doubt that the derivatives resulting from the securitization of real estate mortgages were the core problem? Had not these instruments existed, would there be any crisis today? So why would this discrete problem result in the automatic wholesale questioning of all of capitalism? At the very least, should we not first examine these derivatives to see if there was something peculiar and different about them or their treatment as opposed to their being indicative of a fatal flaw in all of capitalism?
The fact is: there is something different. The failures that led to this sub-prime mortgage crisis are, at their core, the same type of failures that caused the more widespread market crash of 1929. In both instances there was wild speculation in unregulated securities. As L. Gordon Crovitz pointed out in the March 30, 2009 edition of The Wall Street journal, FDR’s choices in the bleak days following his inauguration were extensive market regulation on the one hand, and laws mandating full transparency and disclosure on the other hand. In opting for Louis Brandeis’ philosophy that “sunlight is the best disinfectant,” FDR chose the disclosure route that took its form in the Securities Exchange Acts of 1933 and 1934. The result was that America’s capital markets led the world for the rest of the century in robustness, strength and prosperity. Innovation and entrepreneurship blossomed here like nowhere else in the world.
The problem with mortgaged-backed securities, however, was that they fell into a loop-hole in our system of transparency and disclosure, so their carcinogenic propensities could be hidden for many years. As Mr Crovitz points out, whereas the typical traded stock has tens of thousands of relevant data points that analysts use to make investment decisions, these derivatives have only around 600. With their flaws hidden from view, these instruments proliferated rapidly in the rich Petri dish of our financial exchanges.
So why not merely apply the same medicine to these new securities as that which worked so well with all others? What is the allure of abandoning our successful system and adopting the European system? Indeed, has anyone even asked if the underpinnings of the European system are at all consistent with decidedly American values, culture and approaches? Let me therefore first briefly look at the underpinnings of these two cultures.
The painful truth for Americans is that the two cultures are not compatible. The European model of governance arose within the context of monarchical legacies where businesses existed only with the “leave” of the government. Change was viewed as potentially dangerous and thus had to be supervised and “managed” by the sovereign with paternalistic care. As a consequence, the European business and governance model reflected more of what has been called a “mandatory” approach; that is, unless specifically permitted, everything would be prohibited. Further, it followed that corporations, as a creature of and deriving benefits—such as unlimited life, limited liability for owners, separate legal recognition—from the state, should in turn acknowledge and account for the needs of the society of which it was a part. This was particularly true for the large number of privatized corporations in which the State still retained a significant interest (through “golden shares”) so that the State could be assured that its social welfare policies would be followed.
Unlike the European models of government which evolved from constitutional monarchies, our system established a constitutional democracy. In doing so, James Madison and our other founders sought expressly to reject historical monarchical traditions that, originally at least, provided for the establishment of rules based on the naked preferences of a monarch, and to replace them with a tradition founded on the concept of a “republic of reason.” When one combines that major premise with our derivative traditions, such as all individuals being endowed with equal rights, and that “The history of liberty is a history of the limitation of government power, not the increase of it,” (Woodrow Wilson), we find our culture placing a high value on individualism, and on promoting freedom of contract and choice. In the business context, this resulted in the establishment of a legal environment that sought to enable and enhance whatever a business’ organizers desired to do, leaving to market forces the decision as to which entities would thrive and which entities, fail. Thus, U.S. law is said to follow an “enabling approach;” that is, everything would be permitted unless it was specifically prohibited.
Viewed in this light, it is easy to see why Europeans find greater comfort and harmony in more government regulation and control. However we can also see that this approach is incompatible with American cultural traditions. This, however, only brings me to the more painful question of which system is better.
Capitalism has long been a favorite whipping-boy for both the European elites and the politically-correct liberal left. From a social standpoint, it has little to commend it: success or failure under such a system has nothing to do with your lineage or family background. Pity or sympathy for those who fail is not a variable among its formulations. It ascribes all of the “fault” of a failure to the individual as it does with all of the successes. It gives us no set, pre-ordained formulations as to how to succeed. Under a capitalist system being granted equal rights does not give one any equal share of the country’s wealth; it is one’s talents and industry that are the primary determinants of one’s prosperity. Similarly, the guaranty of freedom of speech does not entitle anyone to have his or her ideas count as much or to be as listened to by our fellow citizens. Not all ideas worth the same.
Capitalism has as basic tenets the unity of responsibility with authority: if you have responsibility without authority, you have no incentive to stick your neck out, no reward for risk; and the spirit of entrepreneurship dies. If you have authority without responsibility, you have a fertile environment for moral hazard; such as a Congress. As George Bernard Shaw pointed out, “Liberty means responsibility. That is why most men dread it.” True, this system, as do all systems, has abuses and may becomes corrupted for a period; but that is why the tree of capitalism—to paraphrase Thomas Jefferson—must from time to time be refreshed with the economic blood of such economic tyrants.
In sum, like the hard and immutable laws of economics to which capitalism is wed, it is regarded as a dismal and unfeeling system.
In contradistinction to capitalist structures that highlight individualism and hold us both in control of and accountable for our destinies, European socialism and liberal political correctness serves to absolve us of our failures and “level” the playing field by putting control of our lives in a paternalistic government that denies our differences and seeks to ameliorate the “harsh” consequences of economic realities. Yet seeking to legislate away our differences and repeal basic laws of economics, ultimately can only have as much effect as legislating control of the weather. Facts do not cease to exist merely because they are ignored. We may seek to walk across a lake based upon legislation that it is now terra firma, but that will not save us from drowning in the attempt.
Men and women are markedly different, and this is a very good thing. It results in the whole being stronger and greater than the sum of its parts. A very good friend and colleague once pointed out to me that if women viewed sex the same way as men viewed sex, there would probably be no inventions and we all would still be living in caves. This may be somewhat of an exaggeration, but it is illustrative of the point. Similarly, my wife has delighted in the joke that the reason why God gave men brains was so that they would not hump women’s legs at cocktail parties. If you reverse the roles of “men” and “women” in that jest, the joke makes no sense and sounds like some banal, misogynistic ranting. Why? Because the sexes are markedly different. Similarly, each sex, religious or other group, culture, country, profession, and human being all have their own strengths, weaknesses, talents and foibles. Ty Cobb was a miserable failure as a human being; but he would be among our choices were we to put together an all-time baseball team.
Putting this in classical economic terms, each individual has the potential of realizing upon his or her own, particular comparative advantage. When such comparative advantages are ignored by mandating an artificial homogeneity among citizens, we all lose out on potential excellence that can advance our civilization, and we doom ourselves to mediocrity, and ultimately, to failure.