In defence of capitalism

Following the recent credit crisis and collapse of several major financial institutions, many commentators have jumped to the conclusion that this proves that the case for free market capitalism is invalid and that libertarian ideals are dead. This includes comments to this effect by prominent people like Nicolas Sarkozy who said “Le laisser-faire, c’est fini” (“Free market capitalism is dead”). The view taken by Sarkozy and many other commentators is fundamentally misguided and suggests a misunderstaning of the real reason for our recent financial troubles. The real reason was not free market capitalism, but quite to the contrary, government interventionism.

Our troubles started with the sub-prime mortgage crisis, which, I think it is fair to say, was the event that triggered the remainder of the problems we have seen. The sub-prime crisis was not caused by free marketeers, but rather by two forms of interventionism. First, the US government offered backing to the two major mortgage backers, Freddie and Fannie. Second, having given them the guarantee of government backing, pressured them to expand their sub-prime lending – lending to people who in a normal (free market) situation would be ineligible for loans on the basis of their credit rating or ability to pay off their debts. Naturally, Freddie and Fannie were more than happy to comply. After all, if the government is guaranteeing your financial position, you can afford to take risks you ordinarily wouldn’t take. So sub-prime lending flourished and as a result many people who were unable to pay off their loans were given loans anyway. A few years down the line, and, surprise surprise, Freddie and Fannie found themselves in a situation where they had vast amounts of bad investments on their hands.

There can be no argument that this sequence of events came about as a result of free market capitalism. Rather, it came about as a result of a misguided, interventionist policy to artificially expand home ownerships rates. This problem was compounded by an ultra-expansionary monetary policy championed by Greenspan et al., which further artificially expanded the amount of bad debt in the market.

Following the government bailout of Freddie/Fannie, their financial woes sent shockwaves of loss of confidence through the rest of the market, which triggered the remainder of the troubles we are seeing today – the collapse of banks and other financial institutions, the decline in world stock markets.

Nonetheless, despite the overwhelming evidence for the real cause of our problems, I haven’t seen many politicians or media commentators call for measures that really address the problems, such as eliminating government involvement in the mortgage market, allowing for insolvent companies to go down, and a more restrained monetary policy. Instead, they’re all too busy calling for the death of capitalism, while advocating bailouts and the injection of more credit.

Capitalism was never the root of today’s problems. Interventionism was. And the only solution is to scale back interventionism and return to free-market principles.

I conclude with this picture…

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