Capitalism Has Failed....

...But why worry when Socialism is there to bail them out.
This is the sorry state of affairs in our capital markets.

Since the forced unraveling of our global financial system a year ago, many Economists have suffered similar unravelings. I was watching "The Warning" on PBS a few nights ago, and what really struck me was the way Alan Greenspan had to eat his own words when he spoke in front of Congress last fall. He basically stated not in so many words that everything he knew about economics and market dynamics were a fraud. Whats more startling was how beat down he was. He was clearly a defeated man in front Congress that day.

"Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself especially, are in a state of shocked disbelief."

Does this mean that the Ayn Rand laissez-faire capitalist leanings were completely wrong? Yes.

Back to laissez-faire capitalism. How in the world can Bankers be ruled by anything except greed? Where in the world did Greenspan ever get the notion they weren't? Ayn Rand that is where.

Anybody who has ever read Atlas Shrugged, Ayn Rand’s 1957 novel, Greenspan’s hands off philosophy of marketplace management sounds very familiar. At its core, the book supports a radically Utopian political/economic system called Objectivism, which suggests that the morality of rational self-interest, as opposed to religious or government intervention, should be the foundation of the ideal political structure.

According to a short description of Objectivism given by Ayn Rand in 1962, "The ideal political/economic system is laissez-faire capitalism. In a system of full capitalism, there should be (but, historically, has not yet been) a complete separation of state and economics, in the same way and for the same reasons as the separation of state and church."

Simply stated, Ayn Rand’s theory of the "morality of self-interest" exactly parallels Alan Greenspan’s testimony late last year about his now "shaken belief" in the ability of "self-interest of lending institutions to protect shareholder’s equity."

What we know have is Greenspan stating "Yes, I found a flaw" when grilled by Congress. "That is precisely the reason I was shocked, because I’d been going for 40 years or more with very considerable evidence that it was working exceptionally well."

Ayn Rand would have been just as disgusted as the rest of us if she was around to watch what was going on last year. But like the rest of us she would be equally powerless to stop it. Mainly because her ideas had permeated the Zeitgeist of Global Financial Markets. Everyone was drunk off Moral Objectivism. They were drunk off of Milton Friedman. They were drunk off of the Committee To Save The World.

To complete this arc:

"My philosophy, in essence, is the concept of man as a heroic being, with his own happiness as the moral purpose of his life, with productive achievement as his noblest activity, and reason as his only absolute." --Ayn Rand

How in world can anyone be stupid enough to believe in such drivel?

But then again we cant totally discredit Rand. She cant be the biggest influential factor. That achievement has to go to Milton Friedman. Its his Libertarian leanings that led to many structural changes in global markets. Its his total deregulation theme that caused OTC Derivatives to implode global economies. Its his idea that markets generally get it right that led Eugene Fama to invent Efficient Market Hypothesis. The simple idea that markets are always right and will always self regulate is the corner stone of most financial modeling. Its a cottage industry.

But what now? We have Obama who looks to be drinking the same cool aid that Friedman was passing out all of those years at the University Of Chicago. Remember he taught Law there. We are invariably headed for another meltdown. Housing is a 100% government run industry. When was the last time they actually added a job? Bank balance sheets are still soaked with crap. Consumers have started a generational shift to lower debt and save for retirement. There is absolutely zero demand for consumer loans. The banks don't want to lend, that's good, no one wants their money. The excess reserves in the system is very dangerous. $800B worth of very dangerous.

Let me say I still believe in Capitalism. There is a lot of inherent good in it. the inherent bad is:

*Network Finance
*Structured Finance
*Modern Finance

I believe that the above three are all though of as stabilizing forces, but in fact only create the illusion of stability while simultaneously creating the conditions for an inevitable and sudden collapse.

The economist Hyman Minsky once said:

“Instability - is an inherent and inescapable flaw of capitalism.”

Simply put, the whole financial system contains the seeds to its own destruction.

I may sound fatalistic, but with carefully crafted policies one cant blunt the collateral damage caused by financial crisis. What we have seen so far is the same economists who got it completely wrong for so many years in the first place are the first ones saying the recession is over. This doesn't help with the policy side of the equation. Its like "See, we only needed trillions of losses back stopped, now leave us alone!"

There is still some sort of perverse feeling that Neoclassical Economics still works. We need to extinguish the idea of self regulating and self stabilizing free markets. The only type of free markets are self absorbed.

John Maynard Keynes warned that capitalism might fail to maintain full employment. Most economists still believed that free market capitalism was a fundamentally stable basis for an economy. We have Keynes to thank for the acknowledgement that government might under certain circumstances play a role in keeping the economy and employment at a somewhat even level.

While other economists like Friedman won Nobel Prizes, Minsky went along with his life. He studied extensively and received his PhD from Harvard. He was largely forgotten because he was such a huge follower of Keynes. Its from studying Keynes very closely that he found his central theme of capitalism being inherently unstable and prone to great collapses. He unlike the neoclassical economists never fell far the idea of markets trending toward some magical state of equilibrium, capitalism would inevitably do the opposite. It would leap over a cliff.

Minsky's advisor Joseph Schumpeter, the noted Austrian economist coined the phrase "Creative Destruction" from many of Minsky's insights. The two worked together, and Minsky came up with the idea of “Financial Instability Hypothesis.” This theory basically states that borrowers and lenders fuel the economy in a safe way, they stay clear of high risk loans, but inevitably the success they get from safe lending allows them to take on more risk in the reasonable hope of making more money. Does this sound familiar? Its basic behavioral finance as success breeds a disregard of the possibility of future failure. As the debt gets more riskier, those bets are leveraged even more in the attempt to double down. All in all the overall economy would shift from a conservative but profitable environment to a much more freewheeling system dominated by players whose survival depended not on sound business plans, but on borrowed money and freely available credit. Once this type of economy has been firmly established, any panic (LTCM 1998) could wreck the market. If a single firm (Lehman)goes bust, it could trigger a massive deleveraging of bad debt assets. All of this pain then spills over to the real economy, the same economy that ultimately depends upon the now collapsing financial system.

Its like Minsky had a crystal ball at the time he passed away. He warned of the dangers of securitization. Warned against complex financial products.

Today, I am more convinced that the inevitable collapse is upon us. I am not saying next week, next month, maybe not even next year, although I would bet a CDS that it happens a lot sooner then later.