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Monday, March 16, 2009

Re-Imagining Capitalism

"The end is nigh!" Both Capitalists and Socialists everywhere raged (and continues to rage) as more and more banks fail or are nationalized. Each side, of course for their own reason. Naturally, the world continues to ask, "are we socialists now?" If it could be turned into a greeting card, then most certainly, this is the season of fear, uncertainty, and doubt. Fear of what tomorrow might bring. Uncertain of our actions, and doubt that the capitalist way is the best way to raise people from poverty, to further human progress, to spur creativity and innovation.

Alan Greenspan in his testimony to the Committee of Government Oversight and Reform on 23 October 2008 said (emphasis mine):

Those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity (myself especially) are in a state of shocked disbelief. Such counterparty surveillance is a central pillar of our financial markets’ state of balance. If it fails, as occurred this year, market stability is undermined.

What went wrong with global economic policies that had worked so effectively for nearly four decades? The breakdown has been most apparent in the securitization of home mortgages. The evidence strongly suggests that without the excess demand from securitizers, subprime mortgage originations (undeniably the original source of crisis) would have been far smaller and defaults accordingly far fewer. But subprime mortgages pooled and sold as securities became subject to explosive demand from investors around the world. These mortgage backed securities being “subprime” were originally offered at what appeared to be exceptionally high risk-adjusted market interest rates. But with U.S. home prices still rising, delinquency and foreclosure rates were deceptively modest. Losses were minimal. To the most sophisticated investors in the world, they were wrongly viewed as a “steal.”

The consequent surge in global demand for U.S. subprime securities by banks, hedge, and pension funds supported by unrealistically positive rating designations by credit agencies was, in my judgment, the core of the problem. Demand became so aggressive that too many securitizers and lenders believed they were able to create and sell mortgage backed securities so quickly that they never put their shareholders’ capital at risk and hence did not have the incentive to evaluate the credit quality of what they were selling. Pressures on lenders to supply more “paper” collapsed subprime underwriting standards from 2005 forward. Uncritical acceptance of credit ratings by purchasers of these toxic assets has led to huge losses.

It was the failure to properly price such risky assets that precipitated the crisis. In recent decades, a vast risk management and pricing system has evolved, combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. A Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivates markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria. Had instead the models been fitted more appropriately to historic periods of stress, capital requirements would have been much higher and the financial world would be in far better shape today, in my judgment.

"Protect shareholder's equity" is business speak for the compact between a Corporate Executive and investors, creditors and shareholders and by extension, employees that he or she will work for the company that he will put their collective self-interest first above all else. When Managers and Executives screw up--- failure happens. And it so happens that part of shit is Iceland's de facto bankruptcy.

Did Capitalism sow the seeds of its own destruction as Martin Wolf asserted?

As one of many essays in The Nation's Reimagining Socialism series, Tariq Ali points out in Capitalism's Deadly Logic,

"Despite mocking those on the left who, in the past, saw every downturn as an opportunity to proclaim that the end of capitalism was nigh, the authors fall into the same trap. This time, we are told, the "patient may not get up from the table." I don't agree. Capitalism is always faced with crises, which are part of the deadly logic of an economy based on a state-buttressed market system. It has failed many times before but has recovered, including during periods when it confronted real political challenges. Its ability to adapt and survive should not be underestimated, even though it will do so, as before, at the expense of the majority it exploits."

As a side note you might want to check out the other essays in the series. Thanks to @mlq3 for the link to The Nation.

Even as AIG discloses counterparties to CDS, GIA and Securities lending transactions (pd), how can we not have doubts when AIG--- a zombie institution that is now 80% owned by US Taxpayers is obligated to giving executives and employees US$165 Million worth of contractual bonuses?

Seriously? A company that needed the help of the US Government to exist will be paying those bonuses? Surely those executives can return the money. People understand that if you do a good job, certainly it wouldn't be terrible to reward this. But when a company goes under and you're still paid a bonus for a job not well done?

Reward a good job done, but punish a terrible one. That's @davetaylor's point was all about yesterday on twitter. That's the point of his blog on "How do you know when CEOs are being paid too much?" And I agree.

In 1949, Albert Einstein wrote, "Why Socialism?" in it he spoke about the real evil in a capitalist society. He said:

The economic anarchy of capitalist society as it exists today is, in my opinion, the real source of the evil. We see before us a huge community of producers the members of which are unceasingly striving to deprive each other of the fruits of their collective labor -- not by force, but on the whole in faithful compliance with legally established rules. In this respect, it is important to realize that the means of production -- that is to say, the entire productive capacity that is needed for producing consumer goods as well as additional capital goods -- may legally be, and for the most part are, the private property of individuals.

Sixty years later, the world is faced by a Global Economic Crisis and its ferocity, we haven't seen since 1939 1929 (corrected for typo, sorry). Don't get me wrong. We're not in a depression just yet. Bad as it is. A lot has changed since Einstein wrote that piece. In the past sixty years, instead of a community of producers and a separate community of consumers, increasingly the world is moving towards the blurring and the mash-up of the two. The digital and startup culture existing on the Internet will distill. The mantra that should emerge with a Reimagination of Capitalism is: "How can I change the world?"

This is a capitalism that yes, we are driven by profit. Yes, we are protecting shareholder equity. But more than that, we're out here doing this because we want the world to be a better place. "A higher purpose", if you will.

Above video is @GaryVee's #sxsw keynote video via @nicknich3 on friendfeed. Awesome stuff he has there.

The current crisis is precipitated because credit is frozen. That's a problem not just for huge businesses but everyone that needs money to finance some enterprise. The more people are able to borrow money from other than a loan shark, the better they're are, wouldn't you say?

Even as we argue whether or not Obama's and other governments' stimulus is Behind the Curb or not (I think it is behind), arguably, in the here and now, Toxic Assets need to be dealt with. Lenders--- whether bonds, banks or whatnut need the assurance that their clients are solvent to repay them. In other words, get the credit markets flowing again because it is this life blood that keeps people, whether they are from Africa, or Los Angeles, from doing things, from making things, to building innovative new products, to being productive members of society.

Is it a reimagination of socialism that need to take place? I disagree.

Why Capitalism? Money with purpose can responsibly drive the world. It is a Reimagining of Capitalism that need to take place. Capitalism needs to bring back the value of protecting shareholder equity, better corporate governance and then it needs to leverage that money, that profit to go change the world.

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