Bear Stearns and the Moral Hazard

When the tide goes out, you get to see who's been swimming naked. --Warren Buffet

Conservatives of a certain school are found of speaking of the moral hazards of a welfare system. Living on government handouts creates a dependency, a servile status that weakens the human spirit. But the same conservatives often abandon this rhetoric when it comes to bailing out big business, a process that happens repeatedly. At this point, liberals chime in with “moral hazard” arguments of their own.

The problem with both of these arguments is that they are both true and both miss the point. Chronic welfare does indeed create a chronically servile population, and bailing out the rich does indeed create reckless behavior in the market. But isn't it a curious thing that both sides object, and object with objectively good arguments, yet both sides encourage the hazards, each in their own way? What is going on here? Why do we have situation to which nearly everyone objects and to which nearly everyone acquiesces?

Periodically, there are campaigns to limit the extent and generosity of the welfare system. The most recent “reforms” have reduced welfare and, in the process, have destroyed what little remained of the family structure of many poor people. Those who tout “family values” have made it impossible for families by forcing mothers into the labor market at subsistence levels. Still, one can understand the frustration people have with seeing large numbers of unemployed people living at taxpayers' expense. The campaigns to limit big-business welfare have been less successful, and when the irresponsibility of the rich puts the whole economy at risk, the government does not hesitate to act, and act in ways and amounts that dwarf the paltry sums given to the poor.

But if we look at the history of these questions, we find something rather remarkable: welfare, whether to families or businesses, is co-extensive with the capitalist system. Capitalism is the one system which has a fixed starting date, 1535. This is the date that the monastery lands (and later the guild lands) were seized by the British Crown and transferred to private owners, usually for pennies on the pound, immediately creating a new class of capitalists with decisive power over economic and political affairs. One of the immediate results was a collapse of wages and a huge increase in crushing poverty. In order to prevent social chaos, it was necessary to establish the “Poor Laws,” the foundation and prototype of modern welfare systems. At the same time, the Capitalist system, which begins with an act of government violence against traditional rights, sustains itself only by granting greater and greater privileges and subsidies to the rich. Indeed, by 1776, Adam Smith devotes 3/4ths of the Wealth of Nations to documenting, in excruciating detail, the amount of subsidy and privilege given to the “mercantile” class.

There was an attempt to reform the system. In 1832, the liberal party gains control of England and attempts to impose a laissez-faire system of pure capitalism. These efforts continue until the long depression of the 1870's, and collapse entirely with the Great Depression of the 1930's. Since the Second World War, capitalism has achieved a fair degree of stability by a combination of welfare systems, one for the rich and one for the poor. But that system itself may now be on the verge of collapse. We are coming to the point where the moral hazards, on both sides, outweigh the financial benefits, benefits which are evaporating before our eyes. But this is not news, but the entire history of capitalism, a system that has never been able to stabilize itself (see Does Capitalism Work?) Indeed, all attempts to return to the purity of laissez-faire have resulted in the opposite: a growth in government power and debt (see Hayek's Super-Highway).

The dual problem of capitalism was noted by Hilaire Belloc in The Servile State. Capitalism creates uncertainty for both workers and investors. The former lose all bargaining power in the matter of wages, while for the latter, competitive anarchy imposes unacceptable risks. The result is a compromise, the Servile State, which guarentees both sides, more or less. This is system is the opposite of capitalism and the essence of oligarchy. Thus capitalism, a system that claims to be based in liberty, inevitably leads to its opposite, servility on one hand, and aristocratic privilege on the other.

Which brings us to Bear Stearns. Ben Bernanke has received any amount of criticism for bailing them out, but in fact he is just doing his job, and the system would collapse if he did not. It may collapse anyway, but at least he has bought some time to see if there is a way out. Up until now, there always has been a way out, more or less. When something has threatened the system, the government has stepped in to bail out the miscreants. The list of bailouts is impressive: Long-Term Capital Management, the Chrysler Corporation, the Savings and Loan banks, etc. So how do these institutions become so important that their health is a matter of concern to the government?

In the case of Bear Stearns, the Fed reasoned that its failure would presage a failure in the entire credit system, and they were likely correct in that judgment. To take just one area, derivatives, BSC was carrying derivatives with a notional value of $15 Trillion. That's “trillion,” with a “T”. That's more than the entire GDP of the United States of America. Of course, the notional amounts do not represent the actual amount of risk; a derivative links its holder to the risks and rewards of owning an underlying financial instrument without actually owning the financial instrument. Holders of derivatives are betting on small changes in the value of some underlying asset which they do not actually own. Notional amounts are more a measure of the extent of risk rather than the amount; you get such large numbers because a large number of investors are placing bets on the same underlying assets. The actual amount at risk may be only a tiny fraction of the $15 Trillion, but it is a risk which spreads through the entire system. Now, consider that the entire derivatives market exceed $500 Trillion. A failure in one dealer might collapse the whole market. Now, add to that the holdings in sub-primes and other risky instruments, and it is not hard to envision a failure in BSC leading to a failure in the economy. BSC cannot cover their risks; they are “swimming naked,” to use Warren Buffet's colorful term. Therefore it is necessary to “socialize” their risks, which is a fancy way of saying, “let the taxpayer take the risk,” which is to say, “Socialism for the Rich.”

Capitalism has always led to its opposite: socialism for the rich and servility for the poor. This is its entire history. It cannot sustain itself without the combination of socialism and servility. It is itself a moral hazard, and there is simply no use for either side to complain about what is an historical fact.

6 comments:

P.M.Lawrence Friday, March 21, 2008 at 7:08:00 AM CDT  

"Capitalism is the one system which has a fixed starting date, 1535. This is the date that the monastery lands (and later the guild lands) were seized by the British Crown and transferred to private owners, usually for pennies on the pound, immediately creating a new class of capitalists with decisive power over economic and political affairs."

There are at least three things wrong with this:-

- "British" had only a geographical and not a political meaning then (there hadn't even been the union of the crowns of England and Scotland of 1603, let alone the Act of Union of 1707);

- Capitalism also emerged elsewhere in Europe, frequently earlier than in England;

- All this was well under way twenty years earlier than the dissolution of the monasteries (as attested by the comparative material Sir Thomas More provides in his 1516 work Utopia), I suspect as part of the peace dividend after the Wars of the Roses when magnates no longer needed tenants to draw on for fighting, although the dissolution of the monasteries did accelerate matters (Sir Thomas More does point out who was doing the enclosing and evicting, specifically mentioning that some abbots were doing these things, so privatising monasteries was only one factor - had there been no dissolution sooner or later all monastic lands would have had such abbots, and if anything monastic lands had had less need of a tenantry in war and so had always had a higher proportion of sheep to people than comparable secular estates had had).

Oddly enough, as Brad Delong has just acknowledged, Karl Marx was prety good as an economic historian for the period from the late middle ages until his day. If you just take the material and not the interpretations and conclusions, you could do a lot worse.

John Médaille Friday, March 21, 2008 at 9:45:00 AM CDT  

P. M.: I grant you the first point; I should have said "England" rather than "Britain."

As to points two and three, the question is not whether you can find pockets of capitalist ownership here and there, but whether you can find a moment when capitalism becomes the dominant form of ownership. That moment in English history is the seizure of the monasteries. Freehold ownership had, of course, existed for centuries, but it was a subordinate and disadvantaged form of ownership. At one instant, everything changed. True, it was not until the "Glorious Revolution" that the new class could claim a complete victory, but effective power passed to this class under Henry VIII.

By the way, it was not so much the seizure of the land that was the problem, but its re-sale--at bargain prices--to a new group of owners that effected real change. If Henry had kept the land, nothing much would have changed. The copyholders would have paid their fiefs to officers of the crown rather than officers of the Church, but the form of ownership would have remained. But Henry had a revolution to finance, and revolutions are expensive. Each of the Parliamentarians and their allies had a price, and the price was some bit of property that they had coveted.

As for Marx, I don't have much of a problem with the Marxist analysis, just with the Marxist synthesis. They often ask the right questions; they rarely give the right answers.

P.M.Lawrence Friday, March 21, 2008 at 7:12:00 PM CDT  

Think it through. Henry VIII needed funds, but the trick he worked needed people with funds already around. Fiat currency let first the French revolutionaries and then Napoleon work the trick, first in France and then in the countries they occupied or hegemonised, but that wasn't available to Henry VIII. Henry VII had stabilised the weak economy he found by ending the inflationary use of tally stick fiat currency (they were released at a discount as tax prepayments), and that could only have been restarted with a huge discount because of inflationary expectations that had built up after the earlier use - it would have cost too much.

So, there had to have been enough development already in place in England by 1535 for fund owners to be able to come forward at all. Sir Thomas More's account shows the capitalism process at work building that, in 1516.

Yes, the dissolution of the monasteries accelerated things. No, it does not mark the beginning of capitalism in England - because it shows us that a pool of capital had already arrived by then. It marks a point within an established capital base. Call it a turning point if you like - it was that - but not a beginning. For what it's worth, the dissolution proceeded in stages, which makes it harder to pin down a specific date even as a turning point. It's quite possible that later tranches took up capital that earlier ones allowed to develop - but there was some around to begin with.

Vi Friday, March 21, 2008 at 10:57:00 PM CDT  

I'm a bit confused here. I haven't read enough of the history involved to comment on that, but how does the purchase of LAND make the buyer a capitalist? I'd thought that would make him a landlord (or her a landlady, not that that was likely particularly common at the time). To be a capitalist, my belief was that one had to own productive machinery, and for there to be enough such people for them together to control the economy, there had to be a source of power which wasn't available in Henry VIII's time. Such a source only came into widespread enough use in the late 18th century with the harnessing of steam power.

Btw, wouldn't Marxian socialism be another such system having a fixed starting date, beginning in late 1917?

Viking

John Médaille Saturday, March 22, 2008 at 12:06:00 AM CDT  

Viking,
It wasn't the purchase of land, it was the theft of it. It was the enclosure of the commons, the seizure of the monasteries and the guild lands and the turning of them over to a new class. The land was taken from peasants by the king, and from the king by the capitalists. It was the switch from land widely distributed by tenancy and fief, to land held in alodium, in freehold and free of social obligations. It was the switch from a system of customary and fixed rents to "economic rent," or what the market could bear. It was the dispossession of the peasant and the creation of the landless proletariat, who crowded the cities looking for work. It was the collapse of the wage system for the worker and the craftsman, whose wages did not recover for three centuries.

The balance of power changed completely, dispossessing, in the end, both peasant and king.

As far as machinery goes, it was an age of machines; the Englishman thought he lived in a marvelous new age. Already, by the time of the Doomsday book (1086), there were 5,600 water and tidal mills in England, used in every aspect of industry: grain, fulling of wool, metals. After the change, the pace of innovation slowed and almost stopped, and would not recover until the 18th century.

You can find traces of capitalism in any age in which you care to look for it. But you cannot find it taking over power so quickly and so completely. As far as communism having a starting date, you have a starting date for a communist government, but not a communist system, since such a system is impossible; it cannot feed the people. The best you can do is state capitalism.

P.M.Lawrence Sunday, March 23, 2008 at 7:48:00 AM CDT  

"It wasn't the purchase of land, it was the theft of it. It was the enclosure of the commons, the seizure of the monasteries and the guild lands and the turning of them over to a new class. The land was taken from peasants by the king, and from the king by the capitalists. It was the switch from land widely distributed by tenancy and fief, to land held in alodium..."

There are several dubious points here, some of them rather academic like the difference between an alligator and a crocodile:-

- Although English law recognises the concept of allody, no allods were ever actually created; after the Norman Conquest all lands were ultimately the King's. So, technically, none of this was theft, just seizure without just compensation. For simplicity, elsewhere in this post I will call it "theft" even though that is inaccurate.

- No allods were created when these lands were released either, though de facto control lapsed and many associated property rights were indeed transferred.

- Seizing monasteries was "theft", but the clock doesn't start there; land had passed to monasteries in various ways that were often improper and could be called theft or fraud with equal justice (see the Statutes of Mortmain). Usually, that too led to peasants being turned loose, though in smaller total numbers and over a longer period of time, since monasteries didn't need peasants for a militia base. No further injustice was done by seizing these monastery lands; this land was not taken from the peasants then, that had been done during the Norman Conquest if not earlier (in fact, no English peasant had any better ultimate claim than conquest anyway - how do you think they got there in the first place? Cornwall and Wales may have been different, of course). The real harm done to the peasants was of a different sort, i.e. being deprived of their livelihoods without compensation.

"...the creation of the landless proletariat, who crowded the cities looking for work" - no, they mostly became "sturdy beggars" roaming the country from town to town (not cities, usually), looking for food and shelter rather than work, as commemorated in the rhyme "Hark, hark, the dogs do bark / The beggars are coming to town...". They certainly didn't stay put; each lot's bargaining chip for begging was that they would leave if helped.

"It was the collapse of the wage system for the worker and the craftsman, whose wages did not recover for three centuries"; actually, that had a completely different cause, the Spanish new world driven silver inflation. What the lower bargaining power did was prevent market mechanisms restoring the real wage level - it didn't make it crash in the first place.

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