Sunday, 2 November 2008

Free markets and lefty morons

One of the most depressing features of the current recession is the way in which both the cause and the cure have been hijacked by the extreme left with hardly a whimper of dissent from the Conservative party. It seems to be open season for nutty Marxist theories which have been proved over and again to fail. I will pontificate on their suggested cure another time, today I want to look at what they have said about the cause.

The cause of the recession is easy to identify. Too many people borrowed too much money or, if you prefer, the banks lent too much money to people who could not afford to repay it. Eventually chickens came home to roost and the excess credit now has to be squeezed from the economy. Since the excess credit has been buying goods and services for years it is inevitable that reducing that credit bubble will cause fewer purchases and a downturn in the economy. Very simple. But why did banks lend too much to too many?

Anguished cries of "free markets don't work" have filled the airwaves from the mouths of naive bearded lefties. To an extent they make a fair point because a market with no constraints can lead to exploitation of the weak by the strong. A very obvious example of this is the black market in booze and cigarettes that grew up during World War II when "official" supplies were rationed. Demand was still there and a supply was available through nefarious sources, so the spivs stepped in and fleeced as much as they could. Where they are hopelessly wrong, moronically wrong, is in using the term "free markets" at all.

There are two definitions of a "free market". One is a market which operates purely as an interaction of supply and demand for a given product without any factors outside the control of seller and buyer affecting the strength of either the supply or the demand. Illegal drugs are probably the only products falling into that category today. The other definition is a market without tariffs. This is a very different concept and relates only to trade between nations, it is nothing to do with the current recession (except very obliquely in relation to trade between the UK and non-EU countries.)

The constraints which prevent markets being free markets within the first definition come from various places. Companies have directors responsible for setting their trading policies and are answerable to their shareholders at least once a year. A director who has concerns can raise them at board meetings and shareholders who wish to protect their investment can force changes where the company's business is being conducted badly. Where the company's business involves the supply of goods or services the general law steps in to ensure that customers who buy shoddy or dangerous goods or are given a shoddy service have a remedy. Where the company's business is reliant on external factors, such as the national "standard" interest rate, the acts of the bodies responsible for those external factors affect the company's options. Where the company's activities might be harmful to others, such as the disposal of certain industrial waste, the law steps in to try to keep the risk to an acceptable level. Where the company's business might have a significant effect on the working of the national economy as a whole, it is for government to decide what sorts of controls or restraints are appropriate to keep a sensible balance between the ability of the company to trade and the wider interest of economic stability. Countless other factors apply to affect the strength of either supply or demand for goods and services. The market for goods and services is the interaction between supplier and customer as defined and circumscribed by all those external factors.

It is ridiculous to suggest, as the loudest lefties seem to do, that the market for loans has been a free market over the last eleven years. I say eleven years not only because the current government has been in power for eleven years (why people keep saying ten years is beyond my understanding) but also because there were no problems with bank lending when they came to power nor for several years before that. What failed, what caused banks to lend too much to too many people, was not the essential system of supply-and-demand that is at the heart of any market mechanism, it was the constraints imposed on both supply and demand.

Where too much is being lent for the longer term stability of the economy, an increase in the "national" interest rate can be used to stem supply. Where too much unsecured lending is taking place for the longer term stability of the bank doing the lending, its directors and shareholders can step in. If they do not do so and there is a risk to the longer term stability of the economy, measures can be imposed to rein-in the risk (of which requiring banks to limit unsecured lending to only a certain proportion or multiple of their capital is the most obvious and most easily enforced). None of these steps has anything to do with a free market because there is no free market in loans. And none of them means that markets do no work, what they do mean is that the constraints which define a market sometimes need to be altered. There is no difference in substance between imposing additional regulation on banks where current practices give rise to a longer-term problem for the economy as a whole and imposing additional regulation on food manufacturers when it is found that a particular ingredient used in food is potentially harmful.

In America, which is being blamed by poor Gordon with even greater mendacity than that thoroughly dishonest man usually shows, the constraint on the market which failed was not one of regulation to prevent banks doing what they wanted to do to maximise profits. It was the exact opposite. Legislation was passed in 1977 (under President Carter) and widened in 1992 (under President Clinton) to force banks to lend to those who could not repay on pain of losing their licence to operate if they did not do so. Their credit bubble was caused almost entirely by bad loans the government forced the banks to make. No failure of the underlying market mechanism there, just the usual consequence of simple-minded, lefty, meddling, do-gooding legislation.

Over here the problem was growing through lack of scrutiny of banks' activities by their shareholders combined with lack of governmental action to head the problem off at the pass. One might ask why the government did not act. The answer is simple, it was beneficial to them in the short term to pretend that the country was getting richer and richer. Votes were at stake, their hand on the levers of power was at stake and, to a government for which nothing is more important than having power for power's sake, slowing or reversing the illusion of wealth was unthinkable. The IMF warned of the problem, the three previous Chancellors of the Exchequer warned of the problem, even the Liberal Democrats warned of the problem, but poor Gordon had told a really big lie - a really big one even by his standards. He said boom and bust was over. He said it was now all boom. Regardless of the facts, it was then politically impossible for him to apply the brakes.

There is no excuse for directors of the banks allowing excessive lending which put their businesses' survival at risk. But they did, so it was for the shareholders to knock some sense into them. There is no excuse for institutional shareholders failing to do so. But they did, so the ball was then in the government's court. Not only did the government do nothing to alleviate the problem, the exacerbated it by taxing and spending at such an enormous rate that they needed the bubble to inflate further and further to feed their addiction.

We can blame greedy bankers. We can blame complacent and short-termist shareholders. We can also blame the very thing the lefties look to as the cure to all ills, government. What cannot be blamed is free markets because there is no such thing in banking.

1 comment:

Mark Wadsworth said...

That's a fair summary, but there was a colossal failure of 'bank supervision', i.e. politicians turned a blind eye to this (and in the absence of any sensible shareholder control, somebody has to step in) because it led to ever rising house prices and associated 'feel good' factor (unless you're one of the priced out generation, of course).

In any event, the credit bubble is only half the equation - the point is that most of this credit did not go into productive economy (or even rampant consumerism), it merely served to inflate house prices.

And as we know that is where the real problem lies - the market in housing is the least free of them all because of incredibly restrictive planning rules, which in turn go down well with the NIMBYs who in turn benefit from this because it drives the value of their properties into the stratosphere.

In the short term, we can fix the banks with debt-for-equity swaps, in the long run we can prevent these credit/house price bubbles (and subsequent recessions) with a combination of sensible banking supervision; liberal planning laws and land value tax (to replace all other property or wealth related taxes).

Here endeth.