Grappling with Morality in Markets and “New” Capitalism

“I chose America as my home because I value freedom and democracy, civil liberties and an open society” – George Soros

(Side note: what happened to you George? You used to be beautiful. Now you’re an oppressor just like the rest.)

I picked up a couple of articles today grappling with the obvious difficulties of morality (or the lack thereof) in the free market. One is “A Choice of Capitalisms” by E. J. Dionne. It starts out rather pedantic, as one might expect from a partisan like Dionne, coming out in defense of the Bain Capital attacks generated by the Obama campaign. Once we’re past that though, the issues raised about the market being rigged in favor of the financial elites are legitimate. The market is rigged, and rigged in favor of the wealthy (this is a Republican and Democrat doing, by the way), and that’s not good. There are no solutions here, of course, but we give credit to Dionne for pointing out that things aren’t right. (Our hope of course is that when E. J. Dionne really starts to dig into the issues of financial market fairness, there will be a realization of the true problem and thus the real solution – just as our hope yesterday was that if Barack Obama is really starting to talk about the Golden Rule as a basis for policy decisions, then surely freedom and individual liberty are right around the corner …)

The second article, and far more interesting, is “Derivatives Need a Priest” from over at nakedcapitalism. (To be fair, Dionne is not really writing for a finance-related audience, and thus probably can’t quite make the article as interesting.) The author (whose name I can’t find just now) starts by noting a difference of outlook on the proposition of buying or selling a position in a bond market. Does one ask first “where is this position headed?” and make a move to profit, or does one ask “who gets hurt when this collapses?” and decide from there? It’s an interesting question.

Both articles get at the notion that greed-driven decisions in the market place can lead to bad situations. (The second actually does point to some good reforms that could help.) But if we are to still be free to make our own decisions, the notion of foisting “morality” and “conscience” on those decisions is a bit more than the regulators can hope to accomplish.

The answer is not to mandate a moral code in financial markets, nor is it actually to chide investors for profiting (even if they profit from bad or ignorant decisions made by school teachers and fire fighters who took an untenable position in some commodities market). Don’t get me wrong, I’m all for chiding people – but it’s only going to change a few decisions. The answer here, as in so many cases, is to use the law to prevent people from oppressing one another, from plundering one another, from robbing one another – to use the law to prevent me from violating my neighbor’s rights.

If my neighbor wants to make a bet on the Super Bowl or the price of tea in China then he is free to do so (and I am free to take the other side of the bet). If this were the only thing going on in the market then I suspect we’d be fine. But there is more, as Dionne hints at (as does nakedcapitalism).

The current system is built on public backing of private risk. Banks take deposits (those teachers and fire fighters put their paychecks in the bank). Banks then take those demand deposits and lend them out many times over, making small marginal profits each time but using huge leverage to amp up the returns. When the system works the banks make a ton (that’s the way it is with leverage). When the system collapses the banks get wiped out, and so do the depositors (those teachers and fire fighters). Oh, wait, that’s not what happens. No, the banks have tied themselves to a sympathetic class of victims (a legitimate one). “If you don’t bail us out, granny won’t get her Social Security check back” – and so we do. We-the-people, operating as we-the-government, tax we-the-people and give it to they-the-banks because we’ve been told that to not do so would be catastrophe. And we-the-people, operating as we-the-independent-not-at-all-self-serving-Federal-Reserve, print money out of thin air (and thus out of our own pockets) to back those leveraged losses.

If we want to fix the obviously-broken, stuff-money-in-the-pockets-of-the-wealthy-at-the-expense-of-the-poor system, we first must remove moral hazard. If you leverage a demand deposit 50 times over and get wiped out, then you get wiped out! (By the way, the nakedcapitalism article points exactly to this – separating the depositor and lending aspects of banking.) For that matter, if you want to write leveraged, naked derivative positions and the market turns the wrong direction, then you get wiped out!

One might just as easily argue that you cannot, for the sake of your own profit and leverage, create something out of nothing. That perhaps the laws should inhibit people from inventing “assets” out of thin air for their own profit. (If the “bet” works they’re richer, and if it doesn’t they’ve only lost a fictitious thing – and the people who agreed to hold the other half of the “bet” get nothing.) In banking we’d call this “sound money” … it’s an interesting and quite Biblical concept.

Doing this is simple, though not easy, and that is the rub. It is simple to institute a system of sound money and to remove moral hazard. It is difficult because all of the power players currently profit handsomely from the system and have no interest in changing it. And all of the liberal commentators fail to come to the conclusion that the way to protect the people from being plundered by their neighbors is to remove the authority of the neighbor to pick pockets and call it “banking” … such a realization of the benefits of limited government rarely dawn on folks who view rule by the brilliant elites as the answer to our problems. Oh, the elites are brilliant alright – they’ve figured out how to live at the expense of everybody else.

Now listen, you rich people, weep and wail because of the misery that is coming upon you. Your wealth has rotted, and moths have eaten your clothes. Your gold and silver are corroded. Their corrosion will testify against you and eat your flesh like fire. You have hoarded wealth in the last days. Look! The wages you failed to pay the workmen who mowed your fields are crying out against you. The cries of the harvesters have reached the ears of the Lord Almighty. You have lived on earth in luxury and self-indulgence. You have fattened yourselves in the day of slaughter.You have condemned and murdered innocent men, who were not opposing you. – James 5:1-6

What makes capitalism “moral” (to the extent that it can be considered moral) is not that it provides some good outcome or even prosperity – what makes it moral is that it is FREE. What makes it brilliant, what makes it work, is that the free will decisions of individuals (creative individuals, made in the image of the Creator) actually results in a vibrant and productive economy. What corrupts capitalism, on both fronts, is the removal of freedom. As soon as I am able to infringe upon the freedom of my neighbor, capitalism has lost its morality and its brilliance. It has lost morality because my neighbor is no longer free – he is my subject. It has lost its brilliance because my free will decisions have now been divorced from consequence, and I am thus “less informed” in making them, and more liable to mess things up because the outcomes don’t affect me anymore – at least not in the negative.

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