While lazing about the house one Sunday morning while my partner was out to lunch with a friend, I decided to take advantage of her absence to watch a documentary on the Netflix instant play (she’s not a huge fan of political or economics films, so this was a bit of a treat for me). While scrolling through the enormous selection in their database, I happened upon Michael Moore’s Capitalism: A Love Story. Now, given his propensity for ignoring nuance and shamelessly appealing to emotion, I’m generally not a huge fan of his work. However, given his influence among the statist left, I figured it’d be interesting to get a sense of his interpretation and framing of the financial meltdown, so I made a bag of pop-corn and settled in for a viewing.
All in all, I was pleasantly surprised. Sure, there were generous helpings of the shameless heart-string pulling and agenda-driven propaganda that Moore’s films are known for. However, he also does a decent job of laying out a good portion of the facts of what happened during the boom, bust, and bailouts we experienced over the last decade. In that aspect of his film, I felt like it was roughly equivalent in usefulness to Inside Job, the fantastic investigation into the financial crisis that won this year’s Academy Award for Best Documentary. Both films do a fine job of showing how the enormous fraud and subsequent politically corrupt bank bailouts played out historically; however, I also find that they fall flat in their attempts to prescribe a solution to the problems they so skilfully demonstrate.
The fixes that they advocate are representative of the overall left-liberal narrative of the financial crisis. The argument goes that, at the dawn of the millennium, the Glass-Steagall Act was repealed. This Depression-era regulation served to separate the functions of investment and commercial banks, and its repeal caused the banking sector to go on a hog-wild frenzy of complex transactions that served as a cover for an enormous wave of fraud in the mortgage market. This, in turn, resulted in an entire sector of our economy assuming the characteristics of an enormous Ponzi scheme, which came crashing down in 2008. The solution, liberals argue, is for the Federal Government to re-establish tight regulation of financial markets in order to ensure good behavior on Wall Street and prevent further calamities.
As far as it goes, I believe that this narrative has great descriptive value; the repeal of Glass-Steagall was, indeed, one of the major factors that allowed for the financial crisis to get out of control. However, I also think the purveyors of this line of reasoning fail to grasp an important piece of the puzzle. Underlying their model is the assumption that the behavior we observed during the meltdown is rooted in human nature. As a result, they believe that all financial markets will “naturally” behave in the same fraudulent manner if left unsupervised by the state.
The fatal flaw of this perspective lies in the fact that financial markets (and by extension, virtually all markets) are not primarily made up of atomized individuals, but, rather, people whose incentives and opportunities are powerfully determined by the institutions in which they are embedded. Far from being “natural” or fixed, the structures of human-created organizations can be as widely varied as the limits of the human imagination, and, in a totally free market, the ownership and incentive structures of firms would be essential factors in their performance. As a result, competition would pressure firms to organically evolve towards the structures that most appeal to consumers.
If all of that seems a bit abstract, let me provide a brief hypothetical example from the financial crisis. The Federal Government’s bailouts saved an enormous number of banks, many of which likely would have become insolvent and failed. By contrast, during the same period, only a tiny number of credit unions were in serious jeopardy, because the ownership structure of credit unions (the depositors are also the owners) steered the institutions towards more conservative, risk-averse behavior than their joint-stock cousins. Had the Feds not intervened on behalf of the banks with seven hundred billion dollars, many of those banks’ large depositors would have suffered serious losses. Furthermore, they would have noticed that their peers who’d kept their money with credit unions had not taken haircuts, and would thus subsequently view credit unions as safer places to store their deposits than banks. Credit unions would then find it easier to attract deposits, and banks would have to engage in an enormous amount of self-regulation to remain viable institutions.
As such, the effect of government regulation of financial markets (and of the economy in general) is to subsidize sub-optimally structured firms. A co-operatively owned credit union is inherently more trustworthy to a depositor than a for-profit bank, but regulations artificially level the playing field by establishing the State as a guarantor of the good behavior of banks. In good times, the shareholders of these firms reap the benefits of this subsidy; when their companies screw up, however, the whole of society often ends up paying for the inflicted damage. As a result, our economy is chock-full of firms that would succumb to more efficient, just, and trustworthy business models in a truly free market, but persist thanks to the legitimization that the state provides.
Given all of this, the proper response is not, as Moore and other liberals would have it, to create new reams of regulations. While creating temporary stability, such a regime would simply serve as a fig-leaf for the abuses and dishonesty that stems from the very structure of many presently existing businesses. Instead, we should go to the root of the problem and eliminate the entire regulatory regime. By opening up competition between different kinds of firms and forcing them to fully internalize the costs of their behavior, consumers would begin to take into account the structure of a business when deciding where to deposit their money, buy their groceries, etc. The best that regulators can hope to do is curb the worst excesses of fraudulent and exploitative behavior; by contrast, fully freeing our markets will finally provide us with the opportunity to witness the flowering of an economy that truly works for all of us, not just a handful of well-connected plutocrats.