Forbes: Capitalism will save us …

Steve Forbes has a lengthy article explaining both the history of the financial collapse and the history of financial collapses in general, in today’s Forbes On Line.  Anyone wishing to understand how bubbles form, why they collapse, and how government causes most of the problems surrounding them, should take time now to read this article.  Forbes insists that capitalism and free-market principles will save us from disaster, if we’d only let them work properly:

Despite the crisis, the global economy still retains enormous strengths. Between the early 1980s and 2007 we lived in an economic Golden Age. Never before have so many people advanced so far economically in so short a period of time as they have during the last 25 years. Until the credit crisis, 70 million people a year were joining the middle class. The U.S. kicked off this long boom with the economic reforms of Ronald Reagan, particularly his enormous income tax cuts. We burst from the economic stagnation of the 1970s into a dynamic, innovative, high-tech-oriented economy. Even in recent years the much-maligned U.S. did well. Between year-end 2002 and year-end 2007 U.S. growth exceeded the entire size of China’s economy. Obviously China’s growth rates were higher, but China was coming off a much smaller base.

The world is flush with cash. It’s frozen because of fear, but the cash is there. Productivity gains are burgeoning.

So, will this global boom resume next year, slowly at first and then with increasing momentum? It should. Whether that happens, however, depends on the next, highly dangerous phase: the political aftermath.

Will we and other countries pursue policies that hinder growth and retard or abort a full-blown recovery, e.g., regulations that stifle innovation and taxes that harm the creation and deployment of capital?

Forbes backed the bailout plan, and he explains why briefly before discussing both history and future.  Thanks to mark-to-market rules and the effects of naked short-selling (and especially because of the elimination of the uptick rule on short selling), banks started collapsing even though all of them had positive cash flow.  The mark-to-market rule forced them to report losses they hadn’t yet taken, and short sellers went wild when they did.  The Bear Stearns collapse taught large depositors to get their money out fast when their banks started looking even a little shaky, starting a panic.

Only the massive infusion of liquidity — or really, the promise of the infusion — stopped the panic.  Interestingly, Forbes points out that Fannie Mae and Freddie Mac (and other institutions) have only collapsed on paper, thanks to the mark-to-market rule.  With mortgage-backed securities having nomarket (and therefore no value) at the moment, they had to report massive losses in assets, even though most of the mortgages are sound.  Both GSEs have positive cash flows, and neither have had to touch the $200 billion credit line that rescued them.  When the market gets recreated for MBSs in a more rational manner, most of the losses will probably vanish, leaving institutions stung but hardly destroyed.

With the initial panic gone, Forbes wants to see an end to government distortion of markets for political purposes — and not just in lending markets.  He prescribes a much more limited role for the Fed and a strong-dollar policy that eliminates speculation in currency.  Government needs to regulate the market, Forbes writes, but in rational and non-political ways that protect the free market.

Unfortunately, Forbes fears that the wrong lessons have been learned from the collapse.  He notes that the Great Depression not only got worsened by the notorious Smoot-Hawley protectionist policy, but it also triggered the intial stock collapse of 1929.  Raising taxes to eliminate the federal deficit — Herbert Hoover’s last-gasp 1932 action — destroyed the American economy as capital fled and banks collapsed.

We need to continue to reward risk and support capital investment.  This is not a moment for governments to decide that they need to “manage” markets, but to recognize the damage they’ve created by doing that over the last several years.

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