Capitalism Works — When It's Not Corrupted

Market capitalism is getting the blame for things that have nothing to do with it. Several examples will make my point.

Several years ago, two judges in northeast Pennsylvania (Democrats, in case you’re curious; I’m telling you because the Associated Press won’t) put together a kickback arrangement with the owner of two area juvenile detention centers to refer youths brought up on even the most trivial of charges to those facilities instead of prescribing probation, community service, or other less stringent sentences. The now-former judges, Mark Ciavarella Jr. and Michael Conahan, collected $2.8 million over the course of the “enterprise.” The former owner of the detention centers has already pleaded guilty and the two recalcitrant judges were recently indicted after their plea-bargaining sincerity failed to impress the case’s judge.

Thousands of kids who made minor mistakes (one teenage girl’s crime supposedly warranting detention was “making fun of her school’s vice principal on a Myspace page”) are scarred for life, and it’s likely that more than a few have become career criminals, something that would never have happened if the judges had not hatched their outrageous scheme.

According to filmmaker/provocateur Michael Moore, the sordid episode just described represents a failure of capitalism. The saga is supposedly such an obvious failing that it is part of Moore’s just-released Capitalism: A Love Story. Moore openly describes capitalism as evil.

Here’s a bigger one. In the 1990s, Enron, a former consulting client of New York Times columnist and economist Paul Krugman and a recipient of his praise in a 1999 Fortune column, built up a unique enterprise engaged in energy trading. While it was in essence a transactions broker, it did fine, in fact revolutionizing what had been a pretty staid business. But over time, it built a pressure-packed, corner-cutting corporate culture that was deliberately created by the suits in the executive suite. Out of this environment came top management’s deliberate choice to abuse the employment of “special purpose entities” to the point where they were barely disguised empty shells designed for the sole purpose of fooling the credit rating agencies. This decision, combined with the 2001 fall in energy prices, led to the company’s shocking multibillion-dollar collapse in late 2001.

Enron’s fall, along with that of Worldcom and several other companies, led to the passage of the Sarbanes-Oxley Act of 2002 (SOX). The law imposes onerous new accounting, control, and reporting requirements on public companies, but especially on those considering going public. By 2006, Hong Kong was doing a higher volume of initial public offerings than New York. In 2008, both Hong Kong and Australia did more deals. It’s a virtual certainty that many growing companies that would once have gone public at the opportune time have instead chosen to be acquired. YouTube’s decision to sell out to Google in 2006 is likely one such example.

SOX’s wave of new rules, regulations, and constraints came about, according to popular mythology, because capitalism had failed.

Here’s an even bigger one. In 1977, Congress passed the Community Reinvestment Act (CRA). Initially, it was meant “to encourage commercial banks and savings associations to meet the needs of borrowers in all segments of their communities, including low- and moderate-income neighborhoods.”

“Encouragement” was not enough for the coalition of grievance mongers and big-government types who conceived CRA. In 1989 “the CRA was amended to require public access to CRA examination evaluations and performance ratings. … [Then] in 1995, the CRA evaluation process increased the emphasis on actual lending and decreased the emphasis on banks’ documentation of their efforts to assess community needs.”

In essence, an encouragement process turned into bean counting.

Then in 1999, in the name of increasing minority home ownership, government-sponsored enterprises Fannie Mae and Freddie Mac (Fan and Fred) began to underwrite risky “subprime” loans, relaxed credit standards required to qualify, and took the loans off the books of the financial institutions that originated them.

Not surprisingly, financial institutions got into the business of originating a lot of these loans. Also not surprisingly, a lot of these loans, now on the books of Fan and Fred, went bad. Both entities crashed and burned last year. Since then, taxpayers have dumped $85 billion. The ultimate price tag will be in the hundreds of billions.

Many entities that kept these loans on their books or speculated on the price movements of securities collateralized with these loans have also failed.

Leftist “wisdom” says that the failures just noted, and the accompanying steep decline in housing prices, represent failures of capitalism.

To no one’s surprise, the three failures described here, all allegedly laid at the feet of capitalism, mean that the government simply has to get more involved than it already is. Specifically, capitalism’s disbelievers say that:

• Prisons and other public services should not be privatized.

• Public companies must spit out more reams of printed paper and consume more gigs of bandwidth producing stuff that no one will read until they consider legal action.

• The Treasury Department and the Federal Reserve simply must establish an ironclad grip on the mortgage market and the banking system.

The free market answers are much simpler, more elegant, and will lead to more long-term wealth and prosperity:

• Privatizations of services traditionally handled by government that will save money without affecting quality should be permitted under strict competitive-bid arrangements. In the case of prison systems, judges should conduct themselves ethically and honestly (imagine that). It’s not capitalism’s fault if they don’t.

• Public companies should be transparent and ethical; the overwhelming majority were that way before SOX and are still that way now. If we want our economy to be competitive with the rest of the world, the provisions of SOX requiring hundreds of thousands if not millions of hours of ridiculous busywork must be repealed. It’s not capitalism’s fault if management doesn’t obey the law and run an ethical enterprise.

• The government should get out of the housing market completely and let prudent lenders be prudent lenders without the perverse, state-inspired, standard-destroying incentives that brought on the mortgage-lending debacle. Then it won’t be capitalism’s problem if lenders who take on too much risk fail; it will be those lenders’ fault alone.

The only things preventing these solutions are an ethical ruling class and courageous free market advocates willing to buck the conventional wisdom until it breaks.

I wrote that the answers are simple. I didn’t indicate they will be easy to put into place.