Flutterby™! : Defining free and structuring markets 2009-03-28 16:39:52.058033+00

Defining free and structuring markets

2009-03-28 16:39:52.058033+00 by Dan Lyke 19 comments

Philip Greenspun: Financial collapse shows failure of free markets? Depends on how you define "free" and structure your markets.

What free markets? What free (uncontrolled by corruptly purchased and enforced law) legal system?

Although much as the proponents of Marxism claim that "true" communism has never been tried, it's hard not to make the same observations in similar contexts about free markets.

Funny this boom and bust was government caused and now they try and blame capitalism.

The government should stay out of business - its none of its business. We should follow the constitution.

Atlas Shrugged is enjoying the highest sales since 1957 - it is now #20 on Amazon.

#Comment Re: made: 2009-03-31 14:41:37.639756+00 by: mvandewettering

As amusing as it is to hear a Communist complain that true communism

has never been achieved, I find myself vastly more frequently bemused by the assertions of many self-proclaimed Libertarians that if we only had truly free

markets, we'd enter a golden age of peace and prosperity.

When I ask them for evidence of some previous time where a Golden Age of Free Markets occurred as evidence that what they said was true, they mumble just as the Communist did, or perhaps blurt out something about a time when we were on the Gold Standard, and probably were able to own slaves.

I'm sorry folks, but markets need appropriate regulation. The economic distress we are having now is a failure in regulation. Financial institutions were able to invent, package, and sell "securities" (an odd thing to call them, given how insecure they were) and were able to do so in large part because a sane system of regulation didn't exist to keep them from doing it. All the incentives to decision makers were established to provide incentives to do the wrong thing

and regulation is one of the tools to change the incentive matrix. Like "if you do this, you won't make billions of dollars, you'll go jail."

The markets of the past administration weren't "free" by any stretch of the imagination, but they were dangerously unregulated in a number of ways. The market being the way is, a tragedy of the commons situation asserted itself, and now we are having to reseed the commons.

MarkV, agreed. I've been trying to figure out how to write this, and I think you said it well.

I don't think it's solely "lack of regulation" that is at fault, but a combination of "lack of regulation" (as you point out), failure of regulation and bad regulations (possibly the Community Reinvestment Act).

Perhaps we need an update of the Sherman Anti-Trust Act to prevent firms from getting "too big to fail" (to me, that creates incentives for firms to get really large such that failure is socialized yet successes are still privatized).

I think the right thing to do for a truly free market is to remove the legal notion of a corporation. That removes much of the disconnect that allows a group of individuals to gut the value of the entity while protecting their own short-term profits.

I also understand that we wouldn't have nearly the standard of living we have today if that were in place, so compromises are necessary.

On the responsibility of the CRA for this mess: A couple of people have pointed out that the actual housing bust is actually only good for a couple of hundred billion bucks. It's not that there's a bunch of bad loans out there, that pales in the face of the actual dollar amounts involved. It's that a bunch of shysters sold leveraged products based on bad data derived from historical performance of those bad loans. The actual dollar amounts of the bad loans are miniscule relative to the exposure of the leveraging.

And on the history of capitalism: I'll toss up the recession of 1873 'til whenever, and note that now that I've learned a little bit about how the construction of railroads in this country was actually financed, as much as I still adore Atlas Shrugged

there's no way I can read it with a straight face, ever again.

As far as regulating markets go, what would be wrong with just monitoring for fraud and coming down hard on every instance of it found? I have no problem with risky investment vehicles as long as the risk isn't being hid from me.

Larry, I think the issue there is that defining "fraud" is very difficult. Many businesses work on information inequalities. Defining the grey areas when they're not passing along those information inequalities to their customers, what's fraud and what's just keeping trade secrets, is the hard part. Further, it requires that customers then carry the complete economic load of educating themselves about their vendor's issues; are you prepared to re-do the calculations that your insurance company does in order to determine if their reserves are sufficient to actually back the insurance product that they sold you? If they miscalculate their reserves and go bankrupt because of a large event, when is that fraud?

If I buy a company, sell off the functioning bits of it, take bonuses because investors overvalue the remainder, and then retire before investors realize that I just sold off the value of the company, is that fraud? Heck, they knew I was chewing through the long-term value of the company, it was all there in the quarterlies, right?

In the case of the railroads that I mentioned, the railroad barons took government bonds, paid sub-companies that they controlled to build the railroad, taking huge profits along the way, and when the bonds came due, oddly enough, the railroad corporations didn't have the money to pay back the government bonds. Suspiciously, their combined personal worths have been estimated to be eerily close to the values of the bonds that didn't get repaid, but you'd be hard-pressed to go back through and find the specific prosecutable instances of fraud. Lots of people tried.

Now, admittedly that's just one of many reasons why the government shouldn't be funding private business, but I think overall the problem is that it's just too much of an economic cost to have to dun every vendor. I have enough trouble learning enough about construction best-practices in order to ride herd on the people I hire to work on my house; sure there's building code and a building inspector to enforce that code, but I want to go beyond that in many cases. That's a lot of reading and a lot of mental load, and given my experiences just getting folks to work up to code I'm glad that there are those basic standards in place.

And it's easy to say "oh, third parties will step in and provide reputation management", to which I just point to the current situations with various organizations that are trying to provide information on doctors and other professions, and to bond rating agencies.

#Comment Re: made: 2009-04-01 03:36:24.261732+00 by: mvandewettering

The problem with corporations which are "too big to fail" is that they enjoy a lack of risk that companies which can fail do not. Take Fannie Mae for instance. They have a sweetheart deal with the government which basically is "if you get into trouble, we'll cover you". If I had s such a backing, I'd sure as heck decide that I could accept more risk, and would engage in riskier investments (in the form of loans) with the knowledge that if everything went belly up, the goverment would come in and bail me out. So, Fannie Mae starts giving mortgages to higher risk clients. To gain new markets, they start offering sub prime loans. Other lenders then have to start accepting higher risk investments too, otherwise investors will shift their money away and they will lose market share. The problem is that *those* lenders are perhaps *not* too big to fail, but they are competing with behemoth that can't. Of course, in the end, Fannie Mae was too big to fail. Many lenders simply folded up their tents and failed. Fannie Mae was bought out. Fannie's profits were privatized. Their losses were socialized.

We're facing this again with the auto industry. To a first approximation, GM makes crappy cars that nobody wants. They rode the SUV craze and made lots of money when gas was $1 a gallon, but had no plan to build a car that someone would want in a $4 a gallon market. Additionally, they pay almost twice as much per hour for labor compared to companies like Toyota who operate plants inside the United States. This is in no small measure because they agreed to labor contracts and pension plans the likes of which those of us who live in the real, non-Detroit universe can only dream of. They are now claiming that they are too big to fail.

We'll see how that goes. Although, frankly, compared to AIG and the banking industry, the car industry seems like a pittance.

My guess is that "free market" can only exist when each participant is representing his own and only his own interest. The corporate form of organization separates the interests of those with the power from the interests of the owners, as well as the other contributors to the business (suppliers, labor and lenders).

I'm irked, also, when politicos rant about the failure being due to trying to regulate with the last century's tools. In fact, the last century's regulatory tools (Glass-Stiegel, e.g.) were systematically, and cynically, removed in the 1990s, due to the influence of those who ultimately brought down the house for their private profits. I'm disappointed that nobody has, as yet, used the term "high treason" in talking about those whose unbridled greed wrecked capitalism for the foreseeable future.

Dan, definitions are what juries are charged with determining followed by appeals courts. I really can't see how basing regulations on fraud leaves us with any more or less of a conundrum over who gets away with what than what we have now. If we look at the banking mess that exists now it all stems from someone convincing a bond rating company like Moody's or Standard and Poor that the securities that the bad loans were wrapped up in were investment grade rather than junk. That's fraud. Isn't it?

You guys are blithly advocating fascism - so Atlas Shrugged the movie coming very soon will likely make you very unhappy. Oh so little vision and morality is needed when you think you have guns on your side.

Larry, I'm not sure if it's fraud. Or, more so, I'm not sure if the down-side of it having been fraud is enough to discourage someone trying to take the up-side. In this case you have a bunch of people who took bets without the reserve to pay off if they lost. Seems like fraud to me, but it was institutionalized in a way that made it a decision of the corporations, so the guys who actually took the bets (and got paid for taking the bets) have walked on (and are still claiming the corporations are liable to pay them for their judgment).

We should have been looking to make sure they could cover their bets before they sat down at the table. That's what Glass-Steagall was about. That's what a lot of the financial regulation that Ziffle rails against was and is about. We, societally, didn't, and now there's no possible way to cover against the fraud now: Do we go after the contractor who built the mansion in Greenwich? The bartender who served the lunch-time Martinis? Shouldn't they have known they were receiving ill-gotten gains? Is there any punishment that's sufficient? If, for instance, you told me that I could spend the next 30 years with tens of millions of dollars in disposable cash to fling amongst my compatriots and pass along to my loved ones, but in exchange I'd have a chance of spending my last decade or so in a minimum security prison... well... I'm reading the contract carefully.

And, in fact, it could be argued that the bailouts are, statistically, going after that bartender and the contractor, they just leave no room for the virtuous. But how do we determine who is without sin?

Ziffle, I have ceased to believe. Human existence, let alone economic growth, has been predicated on threats of violence and détente. My experience has been that many of those who preach "free market" the loudest are the ones trading most heavily on information inequalities. Utopian dreams are great, but my life's too short to spend struggling towards something that all of history indicates is contrary to human nature.

#Comment Re: made: 2009-04-06 09:59:00.764023+00 by: jeff [edit history]

Very well put, Dan. Here are two articles (one is an interview) which provide supporting detail and summarize your position:

It is now apparent that the banking/finance industry has grown in influence to hold even more clout than our military industrial complex. That's bad news for America, both short-term and for our children's future. Our political leaders are too cowardly to act, and our complicit mainstream media will do little to expose the real underlying fraud ("legalizing illicit Ponzi schemes").

Perhaps the only way to effectively deal with the growing intertwinement between Washington and Wall Street is to park tanks in front of the Fed and fly F22 Raptors overhead. But that wouldn't be a quiet coup. Meanwhile, future American generations are being mortgaged, with no AIG to insure them. All part of what I describe as "classic empire decline."

Enron was essentially a group of people who took bets without the reserve to cover possible losses. Those people are either in jail or escaped by death and they were convicted on fraud charges. And when you have a justice department or the SEC not looking into things they should be looking into no amount of regulations are going to work.

The same players (people) tend to move from one company or agency to the next. They typically don't go to jail, though. If so, not for very long.

#Comment Re: made: 2009-04-07 10:34:15.535137+00 by: jeff [edit history]

While I'm not a socialist, here is a brief article confirming this... We currently live in a morally corrupt capitalistic society. New Zealand, anyone?