A short blip after last week’s events in Wall Street

September 21, 2008

Last week has been a historical week for the international capitalist system.

For an overview, The Economist’s coverage of the matter is always a good reference. The world’s biggest insurer (AIG) was… nationalised! In the most unlikely of places: the United States of America. Global investment banks that seemed thriving and immortal just disappeared: an unprecedented bankruptcy (158-year old Lehman Brothers), and a takeover (Merrill Lynch). In the UK, a mega retail bank was created with HBOS being taken over by Lloyds TSB. An almost apocalyptic demise of capitalism: company failure, nationalization, and politically orchestrated business concentration. It feels like the 1920s and 30s, like Ayn Rand’s novels…. in short: it is nightmarish.

This is material for stories in the newspapers and historical annals. Getting out of the current financial crisis will require loads of work for the regulators, and much thinking for those who will reorganize the investment banking branch . Fortunately, this is not 1929, and it seems that the Fed and other Central Banks are doing a relatively good job for this crisis not to become a new 1929 (fingers crossed it will work…). What is striking is that we are witnessing an overdue readjustment: there was an asset price bubble in the US and elsewhere based on economic growth and a euphoric macroeconomic situation that lead to higher house prices and therefore a speculative rush to buy houses. In parallel in the US, new financial products were developed that allowed banks to offer housing loans to people who were usually never creditworthy because too poor (the famous subprime mortgages). The high risks of lending to them were bundled, along with traditional assets into various complicated and incomprehensible “structured products” that were sold across the entire and inherently global financial sector, with noone knowing exactly where these “viruses” are. Lax monetary policy in the US kept interest rates low, feeding into the lending and borrowing binge. The world was flush with cash due to emerging market growth and high commodity prices. The US’ international macroeconomic situation was long unbalanced – not least due to unheard-of sums of money invested in its treasury bonds by the Chinese. This was an untenable situation. A good read to follow the build-up of the crsis is Martin Wolf’s columns in the FT since 2006.

Does this mean that we have to halt globalization, or capitalism? Not in my view. The problem is the usual market exuberance under benign conditions and the excesses of innovation first tried out in the economy. Railways (19th Century) and the internet (2001) also had bubbles that burst. The new products – all the derivates and other products developed in recent years – will probably not disappear. But banking will become a bit more boring and traditional again. Back to the old “on ne prête qu’aux riches!”*. At least for a while. Anyway: If such a crisis happens globally or nationally doesn’t ultimately matter. It does hurt in any case – if the publicly damned short-sellers of this week accelerate the crisis or not.

But my modest views are generally unpopular. One risks being considered a capitalist hawk, a blue-eyed globalist (the more in the face of THIS evidence), etc. etc. This is not the case: I do think that regulators face an immense task of avoiding that irresponsible banks wreak the entire economy. Stifling or nationalizing banking will be no solution, however.

My ironic answer is rather: “In the short term, we are all dead”, to invert John Maynard Keynes’s famous phrase.

As the famous Austrien exilé theorizer of capitalism Joseph Schumpeter put it:

“any pro-capitalist argument must rest on long-run considerations. In the short run, it is profits and inefficiencies that dominate the picture. ” ( from his Capitalism, Socialism and Democracy).

Why am I saying this? My next post on Russia will explain why….



* French expression meaning: One only lends money to rich people”


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