Jeffrey Friedman at the AEI has a long post worth reading. Some excerpts:
Only in America and in Pakistan, of all places, do more than 20 percent of the respond-ents think that capitalism works well; the average across the twenty-seven countries polled was only 11 percent. And 23 percent of those polled "feel that capitalism is fatally flawed, and a new economic system is needed."
Ouch. But:
As opinion researchers have long known, terms such as "capitalism" are dimly understood by most people (even by intellec-tuals), so the best way to interpret these results is as a repudiation of the status quo, which most people (inaccurately) call "capitalism" or "the free market."
Probably true - most people think the country is closer to pure capitalism (I prefer the term "free market" since I have no particular interest in the efficient use of capital; but I digress...) than it really is.
He then mentions several things that did not cause the financial crisis, despite numerous reports to the contrary. There's some interesting but oft-repeated stuff on deregulation. But he really hits the mark when talking about the notion that incentive problems created by faulty executive compensation schemes were a cause:
[A]t the aggregate level, there is decisive evidence against the thesis that incentives to take risks caused the financial crisis. The evidence is this: 93 percent of all the mortgage-backed securities held by American banks either were issued by Fannie Mae or Freddie Mac, and were thus implicitly guaranteed by the U.S. Congress (as the American taxpayer soon found out), or were issued by investment banks and rated AAA by one of the three rating agencies: Moody's, Standard and Poor's, or Fitch.[11]
Never mind that these three private corporations had had a legally protected oligopoly since 1975, thanks to another SEC regulation.[12] Never mind, in short, that, protected from market competition, these companies' AAA ratings may have been so sloppy or so deliberately skewed that they understated the risk associated with mortgage-backed bonds. That aside, the oligopoly's ratings produced a concrete result: as is true of all bonds, AAA-rated bonds paid less than lower-rated (AA, A, BBB, etc.), supposedly riskier bonds. Bond investors always trade risk against returns. A high rating connotes safety and therefore always pays lower returns than lower-rated bonds pay--and there is no higher rating than AAA. If bankers were being lured by their banks' compensation systems into acquiring risky but lucrative assets--on the basis of which the bankers would have gotten bigger bonuses--then they should never have bought AAA bonds. Instead, they should always have bought higher-paying AA-, A-, or BBB-rated bonds, but they did so only 7 percent of the time.
That is decisive - if compensation schemes are supposedly encouraging you to take risks, why was the flight to safety in the form of government backed and AAA-rated bonds? That's the opposite of what thing you said...
He then procedes to tell the same story about the recourse rule and other regulations as the source of the crisis that I already blogged about here.
But I think in the whole long post, his most important insight is his "advice" to both conservatives and liberals regarding capitalism. Combined they tell a very good story about why capitalism is a net positive:
Let us start with conservatives, many of whom make the mistake of extolling the brilliance, wisdom, or heroism of capitalists. ... Collectively, they [capitalists] possess no superior powers; their lucky guesses, no matter how well informed, are still guesses. Everyone can see this in the wake of the crisis.
Unfortunately, economists have only grown more obsessed with self-interest--that is, "incentives"--since 1950. This has led many conservatives to embrace the idea that "greed is good"--a woeful misreading of Adam Smith. Smith's parable of the baker, to whose benevolence we do not appeal when we buy our bread, is actually a lesson in unintended consequences, not in the wonders of greed. Even if the baker intends merely to make money, he can do so only by providing his customers with bread. In his case, greed is indeed good. But that does not mean that greed is always good and benevolence bad, nor that all bakers are in it solely for the money. Nor does it mean that greed accounts for the success of capitalism.
[I have numerous Republican friends who would personally benefit from learning this lesson.]
And then for those on the left:
They fail to notice that there is more to capitalism than luck and greed: there is competition--the saving grace of the whole system; the device that turns good luck to social advantage; and, when undisturbed, the source of capitalism's systemic strength.
Competition is the engine that turns the talents of the lucky to the service of all. A baker who offers moldy or bland bread can be driven from the field by a competitor offering a better product. [emph. mine] That is the message of Adam Smith. The successful baker, no matter how greedy his motive for baking bread, must unintentionally mimic the very actions an altruistic Rawlsian philosopher would prescribe. The reason is the competitive nature of the capitalist system; the motives of individual capitalists are irrelevant. Competition puts capitalists' different motives, like their different ideas, to the acid test of consumer satisfaction. This tends to give consumers what they want--or at least what they think they want--and it diversifies a capitalist society's investment portfolio. Capitalism thus mitigates both human greed and human fallibility. This is an amazing achievement, but there is nothing magical about it.
Now consider again the alternatives liberals tend to favor--either the regulation of capitalism or its replacement by something more democratic, like an idealized socialism. Since regulators' or citizens' ideas would then be imposed on the whole economy at once, they could not be put to the competitive test--any more than the conflicting arguments of debaters, the conflicting promises of politicians, or the conflicting forecasts of budget analysts can be tested. If the citizens' or the regulators' ideas happen to be good ones, we all gain; if they happen to be bad, we all lose.
Yes, yes and more yes. How so many can have faith that a course of action is right without any verification is beyond me...
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