All Is Not Right in "Capitalist" America
James Surowiecki, in a piece in the New Yorker titled "Private Inequity," discusses private-equity funds, leveraged buyouts, financial gimmicks, and how it has increasingly been possible to do exactly what Romney's opponents accuse Bain Capital of having done-- essentially, buy out a company, load it up with more debt, cash out on their initial investment (the key part, for them), and leave the company less able to weather tough economic times than when it started.
I am not an economic "populist" as it is commonly defined. I do not know what James Surowiecki's political predilections may be. What he describes may not have been what Bain Capital did. And it is wrong to implicate capitalism itself, or the very idea of private-equity firms, as the culprit here. The attacks on Romney may have been unfair.
But all is not right in "capitalist" America.
Those of us who truly believe in the free market and capitalism, more than any others, need to be vigilant to highlight and prevent abuses of that system, if we care to have it continue. When we turn a blind eye to practices such as those mentioned in the piece, we give ammunition to those who would dismantle or hobble the system itself.
The free market works best when each person's incentives are properly aligned with the greater good. In most cases this happens naturally. A buyer and a seller each have incentives to exchange, and they are each better off by the transaction. Society also benefits. But in a world of complex and arcane rules and regulations, and where high-multiple leveraged buyouts are allowed, firms can risk other peoples' money to buy, restructure and profit from companies without really improving anyone else's bottom line-- in many cases, damaging it.
Isn't this just another form of rent-seeking, of focusing more on transferring wealth rather than producing it?
Again, I'm not saying buyouts and restructurings should never happen. I'm just asking that we ensure those doing so are responsible for the results. If they are, their incentives will once again be properly aligned.
How do we do that? I don't know. I'm not a financial guru. I don't understand all the government regulations that we would have to change, remove, or even put in place. I don't know what kind of banking reforms are necessary.
I do know that all is not right in "capitalist" America, and we only hurt ourselves as conservatives if we ignore these problems or accuse each other of being "populists" or "liberals" for highlighting them.
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May '10
Re: All Is Not Right in "Capitalist" America
Frozen Chosen
Many of the abuses in capitalism are caused by dishonest individuals breaking the law. These people are/should be prosecuted by the SEC and other government agencies.
Thank you. You understand what I am getting at.
Frozen Chosen
Chris, I think the point everyone is making is not that there are no abuses within capitalism but that any attempts by government to curb these abuses through regulation ends up being counterproductive, i.e. doesn't curb the abuses but distorts the market instead.
I agree, and yet there are some who would say the SEC is an example of this, and should just be abolished.
Undoubtedly the SEC is often 1) ineffective 2) corrupt 3) counterproductive, but I'm not about to agree that we should get rid of all oversight and all regulation. I'd agree that we have many bad regulations, but we also have many that ensure it's not just the "law of the jungle" out there.
Mar '11
Re: All Is Not Right in "Capitalist" America
Chris Deleon: Do you understand what I am getting at? Why so defensive?
Can capitalists do no wrong, ever?
Shall we continue to turn a blind eye, just because (sometimes ill-informed) criticism comes from across the aisle?
I think you make a good point, especially considering that we defenders of capitalism often misrepresent the outcomes that can be expected.
However, when discussing criticisms from the left, I think it is important to differentiate between two items: transactions which truly bring no added value to the marketplace, and transactions whose added value is not apparent to the casual observer.
For instance, Russ Roberts (of Econtalk fame) often mentions that certain types of finance may not be beneficial to the market in any substantial way.
Contrast that with LBOs, short sales, bonuses for CEOs, income inequality and other features which may open the gap between haves and have-nots temporarily but are necessary for long-term growth for all.
Our critics tend to lump all these problems together; we should do a better job of explaining the difference.
May '10
Re: All Is Not Right in "Capitalist" America
Matthew Gilley
I've always preferred the old fashioned limit: don't borrow more money than you can pay back. If you break that rule, bad things happen, and no one has to pass a law or issue a regulation.
Except that people tend to fall for extraordinary popular delusions, of which major ones seem to happen on a generational cycle. Case in point: our latest housing craze, in which everyone and his dog was getting 100% mortgages for unrealistically ever-increasing house prices. Of course the government helped promote this (which I agree should not have been the case) but these crazes happen whether governments get involved or not. In this case they just made it worse.
Much of the financial crisis of 2008 was due to over-leverage and the unregulated credit default swaps market, which made it almost impossible for people to properly assess risk.
Simple rules such as limiting the amount of leverage you can use, or requiring 20% down on a house, or requiring more disclosure of financial liabilities, are designed to reduce fraud and our tendency to mass-fool ourselves.
Should we throw out those rules, as we have done?
Edited on Jan 24 at 3:19pmNov '10
Re: All Is Not Right in "Capitalist" America
When I took economics at a pretty liberal college, I was taught that cartels are inherently unstable. In other words, if you let the free market go, cartels will fall apart, because market forces provide incentives for each member of the cartel to break the rules of the cartel.
I recently read Thomas Sowell's Basic Economics, and he makes a less commonly taught but equally convincing case that monopolies are not to be feared--as long as they do not have the ability to keep competitors from entering the marketplace. He talks about Alcoa, which had a complete monopoly on aluminum, but still allowed aluminum prices to drop because there was competition from other materials.
The one way that cartels and monopolies can really be stable is if the government gets involved. Thus, your solution (regulation to deal with cartels and monopolies) is actually the problem.
May '10
Re: All Is Not Right in "Capitalist" America
Lucy Pevensie
Thus, your solution (regulation to deal with cartels and monopolies) is actually the problem.
"My" solution? Where did I suggest what you are saying? This is completely off topic.
EDIT: Sorry, I assumed you were talking to me; I see you are addressing another Member. I replied too soon.
My points are that:
- Our system is not necessarily fully "capitalist," and in our knee-jerk defenses of it against any and all criticism, we actually end up defending a lot of the abuses of it and/or the corrupted versions of it
- Some simple, proven rules are needed; a "law of the jungle" approach may appeal to libertarian purists, but in real life makes it even easier for mass delusions and fraud to occur. I'm not defending the labyrinthine regulations we have now, but I'm wary of abolishing all regulations as some seem to want to do.
Edited on Jan 24 at 3:21pmApr '11
Re: All Is Not Right in "Capitalist" America
Chris Deleon: Shouldn't there be some limits on the amount of leverage one can engage in?
My whole point is that you should be held responsible for the consequences of your actions. As currently structured, I see lots of loopholes that let people get away with putting the consequences of their own risk-taking on others. · 5 hours ago
This was part of what I was doing at the Trade Bank of Iraq, to lay down a possible bias.
If you're borrowing from Citibank, Goldman Sachs, Bank of America, or some such (as most of the leverage was), there is a limit on how much you leverage you can get; the amount that they'll give you. They're not idiots, and they don't want to lose money. More subtly than the hard limit, they will offer different terms for different loan packages. The balance struck is about weighing the various options.
It may be that I'm misunderstanding your suggestion. Are you meaning to imply the creation of a body of law like consumer protection laws that would guard JP Morgan against foolish investments?
Apr '11
Re: All Is Not Right in "Capitalist" America
Chris Deleon: Do you understand what I am getting at? Why so defensive?
Can capitalists do no wrong, ever?
Shall we continue to turn a blind eye, just because (sometimes ill-informed) criticism comes from across the aisle? ·
The defense of Bain is not a defense of all things done in the private sector. Defending Bain and private equity is worthwhile, though
There's two claims you're making here. One is, I think, the suggestion that attacks on private equity are OK, as it does not do good things for the economy. This is a good article rebutting that (it says it's about Bain, but it's not really).
The second is that while you're acknowledging doubt about whether the critique applies to Bain, you're suggesting that it might. It seems worth noting that Bain did not tend to flip companies or buy them up to dismantle them, but kept them, reformed them, and helped them grow before passing them on. If investing in and reforming a fast food chain, for example, to be more successful (without government input) is not amongst the most quintessential form of capitalist acts around, I don't know what is.
May '10
Re: All Is Not Right in "Capitalist" America
Chris Deleon
Except that people tend to fall for extraordinary popular delusions, of which major ones seem to happen on a generational cycle. Case in point: our latest housing craze, in which everyone and his dog was getting 100% mortgages for unrealistically ever-increasing house prices. Of course the government helped promote this (which I agree should not have been the case) but these crazes happen whether governments get involved or not. In this case they just made it worse.
Much of the financial crisis of 2008 was due to over-leverage and the unregulated credit default swaps market, which made it almost impossible for people to properly assess risk.
Simple rules such as limiting the amount of leverage you can use, or requiring 20% down on a house, or requiring more disclosure of financial liabilities, are designed to reduce fraud and our tendency to mass-fool ourselves.
Should we throw out those rules, as we have done?
1. Your language suggests my answer - why legislate an escape hatch for people to avoid consequences of bad decisions?
2. Rules? See James above - these weren't "rules"; they were sound business practices and people are getting burned for forgetting them.
Jan '12
Re: All Is Not Right in "Capitalist" America
Chris - In order for the private equity group to buy a company, there has to be a willing seller (and you noted elsewhere that this buyer/seller transaction is good for them and good for society) so obviously the seller believes they are better off. Also, the lenders into the transactions are generally sophisticated banks and are not lending into the transaction with the intent of losing their money.
Further, the "other people's" money you refer to here generally comes from public pension funds (mostly state governments), private pension funds, endowments, insurance companies and wealther individuals. If these pension funds earn high returns that means that the state or company that runs those pension funds has to contribute less capital to them and can free that capital up for more productive uses.
Lastly, one can always point to scary private equity stories about dividends and bankruptcies but these are a rare ocurrence and occur with no more frequency than in non private equity owned companies. Private equity shops overwhelming make their money from driving efficiencies and growing the business. That is where the big money is made.
May '10
Re: All Is Not Right in "Capitalist" America
Chris Deleon, I do get it. The problem, at root, isn't capitalism or the free-market. The root problem was identified by the Apostle Paul 2,000 years ago. He wrote to his friend in 1 Timothy 6:10, "For the love of money is a root of all kinds of evil. Some people, eager for money, have wandered from the faith and pierced themselves with many griefs."
Ideally, in capitalism people pursue their own self interest in a manner that serves other people. But, unfettered from a moral base, people will pursue their own interest regardless of the impact on others. This, too, was a potential foreseen many years ago. John Adams wrote: "Our Constitution was made only for a moral and religious people. It is wholly inadequate to the governence of any other. We have no government armed with the power capable of contending with passions unbridled by morality and religion."
BTW, I think this is the point Newt was making when he attacked Romney re: Bain. I don't think he was attacking capitalism, per se.
Jan '12
Re: All Is Not Right in "Capitalist" America
Tom - I understand what you are saying but, in total, what is it exactly that Romney did at Bain that you would find objectionable? I do not consider overseeing a failed investment as objectionable. In the rare situation where a private equity firm makes a significant return on its investment in a company but the company later went bankrupt, is that immoral? Is it then immoral that the private equity fund's investors (pension funds, endowments etc) earned that same return? Therefore is the company overseeing that pension fund or the college with the endowment participating in socially destructive behavior? Is society as a whole in the long run better off with certain company's ceasing to exist and that capital redeployed for more productive uses?
Sep '11
Re: All Is Not Right in "Capitalist" America
Lucy Pevensie
... I was taught that cartels are inherently unstable. In other words, if you let the free market go, cartels will fall apart, because market forces provide incentives for each member of the cartel to break the rules of the cartel.
I recently read Thomas Sowell's Basic Economics, and he makes a less commonly taught but equally convincing case that monopolies are not to be feared--as long as they do not have the ability to keep competitors from entering the marketplace. He talks about Alcoa, which had a complete monopoly on aluminum, but still allowed aluminum prices to drop because there was competition from other materials.
The one way that cartels and monopolies can really be stable is if the government gets involved. Thus, your solution (regulation to deal with cartels and monopolies) is actually the problem. · 9 hours ago
I don't follow your logic at all. Anyway, doesn't the US have very tough anti-monopoly and anti-cartel laws? Do you want them repealed?
Nov '10
Re: All Is Not Right in "Capitalist" America
I don't follow your logic at all. Anyway, doesn't the US have very tough anti-monopoly and anti-cartel laws? Do you want them repealed? · 4 hours ago
I'm not an economist, but my sense is that many economists think we'd be better off without those laws.
One example that is used has to do with the New England shoe industry (can't find any reference to this on the web, but it's in Basic Economics.) There was one dominant shoe company in the US. Had to do with economies of scale; it simply wasn't feasible for there to be lots of smaller companies. As I understand it, although it was not in any way blocking anyone else from entering the market, the company was sued under antitrust laws, because it held such a large market share. The end result is that now there is no shoe industry in the US. Maybe it would have happened anyway, because labor is cheaper overseas,
As to the general point, 200 words limits the ability to describe it. Generally, regulation is influenced by large companies who use it to prevent competitors from entering the marketplace.
May '10
Re: All Is Not Right in "Capitalist" America
Tom Lindholtz: The problem, at root, isn't capitalism or the free-market. The root problem... "For the love of money is a root of all kinds of evil..."
Ideally, in capitalism people pursue their own self interest in a manner that serves other people. But, unfettered from a moral base, people will pursue their own interest regardless of the impact on others... John Adams wrote: "Our Constitution was made only for a moral and religious people. It is wholly inadequate to the governence of any other. We have no government armed with the power capable of contending with passions unbridled by morality and religion."
BTW, I think this is the point Newt was making when he attacked Romney re: Bain. I don't think he was attacking capitalism, per se.
Exactly. I don't see a problem with capitalism! It's a neutral system, a tool.
But when we (appear to) defend abuses and bad practices, and/or oppose rules and regulations that sometimes rightly try to reign them in, on the basis that it's an attack on capitalism itself, or on the basis that some regulations do in fact overreach, we weaken our case for capitalism itself.
May '10
Re: All Is Not Right in "Capitalist" America
This is one of the key concepts.
An extension of it is this: In order for the system to work optimally, the incentives caused by self interest must be aligned such that they causes people to pursue things that benefit not just themselves, but others and the system as a whole. In particular, incentives should not be aligned such that people can benefit at the expense of others.
If a system allows this to occur, through loopholes, bad regulations and laws, or through ignorance or lack of full information, that system becomes that much less productive and that much more corrupt.
Capitalism is not so much a system as much as it is just the way things are, the laws of economics at work.
But the system of laws, institutions, practices, etc. that we set up to use capitalism can definitely be reformed and improved. And when they fail, criticizing them does not need to imply a criticism of capitalism itself. But if we fail to reform these systems, the concept of capitalism itself suffers disrepute.