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Private sector revisited

Published on -10/5/2012, 10:24 AM

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Private sector revisited

A recent editorial in The Hays Daily News titled "Private Sector" was misleading, naive and included many gross errors. Among those errors were: a) the assumption that in the U.S. we live in a free-market economy, b) the assumption that government had nothing to do with the recent recession, c) the assumption that it was the corporations that single-handedly led this country to this morass and, d) that further regulation will save the country from collapse.

We do not live in a free-market economy in the U.S. We live in a mixed economy where the mixture varies depending on the industry. For example, the technology industry is not heavily regulated while the financial services industry is heavily regulated. The claim that the financial industry was deregulated is a myth; the fact is that government policies created the conditions for an economic downturn and beyond that, government policy has turned a rough economic condition into a full-fledged recession.

It was government policy that created the bubble in residential real estate and although financial institutions made serious errors that contributed to the crisis, it was government policy errors in the form of government incentives that enabled such company mismanagement. The financial institutions (Goldman Sachs, Citigroup etc.) were not promoting limited government. To the contrary, they were seeking special favors for themselves and are examples of crony capitalism or more correctly, crony socialism. In a free market environment, those companies should have been allowed to fail.

Two things must be addressed within the limited scope of this narrative. First, regarding the derivatives as a major cause for the economic crisis and the companies responsible for it. It is a myth that derivatives were the main culprit for the economic downturn. The market is simply too large, but it was convenient to exaggerate the magnitude of the derivatives market. The majority of the derivatives are utilized to reduce risk not as a speculative mechanism.

In short, although the capital involved (the contracts) was very large, the risk was relatively small. It is easy to say that the derivatives market is worth hundred of trillions of dollars but on the other hand to leave out the reality that the actual risk is a small fraction of the original amount. Goldman Sachs, Morgan Stanley and most of the rest of the investment banks had managed their risk and would not have failed as a result of counterparty risk and there would not be an economic impact. Those not managing their risk should have failed, and they should have prepared for the bankruptcy process to ensure the normal function of the financial system.

Similarly, the idea that companies disappear during bankruptcy is not true. In this case, Lehman was not planning for bankruptcy because it fully expected to be bailed out by the government. The investment houses indeed made some poor decisions, which are attributed to greed but they were actually based on irrational optimism, which was partly created by the Fed. The ultimate question though is this: Was "saving" Goldman and AIG about systems risk or about crony capitalism? The answer is that Goldman is a pure crony capitalist. It makes huge contributions to political parties and politicians and especially to the Democrats. Goldman alumni occupy many high level positions in Washington.

Again, Goldman is not an advocate of free markets but an advocate of special deals from Washington, or a crony socialist. If the U.S. Constitution were enforced, crony capitalism would not work because the politicians and the bureaucrats would not have the authority to hand out favors to their friends. No true separation between economics and state currently exists in the U.S., as it would in a free market.

Second, regarding regulation, contrary to popular opinion, the financial industry was not deregulated it was misregulated. Even during the Bush administration, major financial regulations were passed like the Privacy Act, Sarbanes-Oxley and the Patriot Act. All of those mega-acts were often conflicting with each other and the big cost of those regulations was that it caused banks to divert their management on regulatory risk instead of credit risk.

The regulators also placed emphasis on mathematical modeling for risk management, which all failed. Another myth is that since the crisis in 2008, bank regulators have been encouraging banks to make more loans. The opposite is true.

Although the regulators say that they want banks to make loans, the local examiners are making it more difficult for banks to extend new loans, especially to businesses with debt related to real estate.

Driven by the Obama administration's fundamental beliefs that small businesses are good and that big businesses are greedy and bad, the banking regulators have put tremendous pressure on banks to be merciless in handling business borrowers again, primarily those in the real estate industry. The regulators' arbitrary creation of new risk-grading standards and other rules has made the economic correction deeper than it needed to be. In the end, the negative impact of government regulations is far more destructive that the direct cost.

The government should not try to control the market because it completely fails when it tries. The truth is that the government cannot fix the economy because the government wrecked the economy. Actions taken by the government since the crisis started, will most likely end in reducing our standard of living.

True free-market capitalism, not crony capitalism, is the only hope for recovery and prosperity. As Milton Friedman said: "The society that puts equality before freedom will end up with neither. The society that puts freedom before equality will end up with a good measure of both."

Andreas Maheras

Hays

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