Sunday, September 21, 2008

Regulating the Markets

Last week, Sen. McCain came out in favor of regulating financial markets. That is a departure from traditional Republican orthodoxy that is truly astonishing. For 100 years or more, Republicans and many Democrats have told us that markets are "self-regulating." It does not matter what market you are talking about -- market for consumer goods, for machinery, for finance capital such as bank loans or mortgages -- sooner or later supply will meet demand and prices will reach a reasonable level. Markets do not need government regulation; on the contrary economic problems are caused by government regulation.

But now this orthodoxy has been given up by almost everyone who has trumpeted it for many years including the White House and Republican stalwarts like Sen. McCain. The new orthodoxy is that we must return to a law (adopted during the Great Depression after 1929 and abolished under Pres. Clinton) that separated ordinary banks from investment banks. Ordinary banks are where you deposit your paycheck, maybe open a savings account, and borrow money to buy a house or a car. Investment banks do not do any of that; they operate with large sums of investment funds and, frankly, gamble with those funds trying to make money. For a while everybody wins and then, as is happening currently, the bottom drops out and many people lose. (The CEO’s of bankrupt investment houses walk off with $200 million for their old age.) But we are now being told that all of this could be avoided if only we do not allow ordinary banks to gamble in the way of investment and if, secondly, we kept a closer eye on the investment banks’ gambling.

Not surprisingly, that oversimplifies our problem. In the last 40 years there have been regular government bailouts of private businesses -- the Pennsylvania Railroad in 1970, the Franklin National Bank and New York City in 1975, Chrysler in 1980, the Savings and Loan Banks in 1990, the airline industry in 2002, and now one investment bank after another to the tune of close to $1 trillion.

It is clearly not true that in all these different cases the problem was a confusion of ordinary and investment banking. Many of the bailouts occurred when ordinary and investment banks were still distinct. Our economic system has pervasive problems which our experts and legislators still do not want to recognize.

Here is just one of them. In a capitalist system everyone pursues his or her private interest and the "unseen hand" of the market is supposed to assure us that the outcome will be the best for all of us. You look after what's good for you; I look after myself and you and I and everyone else will be better off. Let's look at that.

Suppose you have a small business. You manufacture specialty paints. Your business does okay but your profit margin is small. Then, one day, you have an inspiration. You see that the cost of disposing of your waste, much of it hazardous, is significant. So you begin dumping your waste in the woods, save the money of proper disposal and increase your profit. That is clearly a good strategy for you but if everybody did this, the Earth would soon become unlivable from all the pollution. The market is not going to make that problem go away. What is good for the individual often is bad if practiced by everyone.

One more example: another way of raising your profit margin is to lower wages. Since your business is small you may even take on a few illegal immigrants and pay them less than minimum wage. The government is never going to check a small business like yours..

This strategy too will increase your profits and be good for you. If all enterprises follow the same policy the large majority of the population would have a lot less money at their disposal. Demand for ordinary consumption goods would fall and some businesses would go broke and the economy would go into a recession, if not worse. Policies that significantly decrease consumer demand are not good for the economy even though they may be very good for individual enterprises.

There is no reason to think that capitalist markets regulate themselves. Capitalist enterprises must be carefully supervised so that they do not adopt policies that are harmful to the economy as a whole.

The current crisis is the result of the religious faith in the self-regulating market -- a faith that has no support in actual fact. It is supported only by the self interest of capitalist enterprisers who do not want to be limited in the ways they make money, even if their methods are in the short or in the long run bad for consumers or the country as a whole.

This blatant self-interest of the pundits associated with business is still at work when they try to tell us that we just need to restore a one law that separates ordinary from investment banks and then everything will be fine. Unless the government takes a firm hand to protect us against capitalists, we will never be fine.

But since the capitalists own the government, for instance because they pay for the presidential of campaigns of Obama and McCain, we are bound to hear misleading diagnoses of our present problems. Ordinary citizens and voters should not believe everything they're told.