Capitalism and free markets.

What a great idea. It’s a shame no one has actually tried it out or bothered to let homo rationalus economicus that it’s an urban myth. We operate mainly in a state sponsored system of capital markets underpinned by arcane and often opaque trading rules and regulations.

The provision of capital is key to any functioning economy and has been since the beginning of time. Each empire had its own approach to coinage to support trade and the governing class or head of state. The first pillar of modern capitalism was established in 1694 with the formation of the Bank of England. Thus began the first stirrings of the fractional reserve banking system and the modern financial system.

I’ve previously covered the many bailouts experienced by the banking system and the Bank of England itself and in some ways our current malaise is no different. The central precept of free markets is that they should operate on their own merits - caveat emptor.

I’m not going to discuss that fallacy here but focus on the problems of bail outs. Why should a failing business be rescued by the state? The simple answer to that is when it has implications for the national economy or issues of national security (often regarded as twos sides of the same coin). We have seen the fiasco in the US, the UK and Europe. We have seen the banking system bailed out, private companies bailed out and yet we still hear the mantra of free markets, trade and market liberalisation and privatisation repeated.

Here in NZ we have seen South Canterbury Finance bailed out and most recently AMI. On both occasions the government intervened to provide capital from taxpayers for businesses which had clearly failed. In the case of SCF depositors were guaranteed under a standard deposit guarantee framework but bondholders also benefitted to the tune of $350m. Those bonds should never have been covered under a deposit guarantee scheme. Investors enjoyed a big free lunch here at the expense of the taxpayer. In the case of AMI, the government intervened to support an insurance company who didn’t have enough reserves on hand post the February 22nd quake. The government could easily make a good case for supporting AMI, in terms of providing it with backstop liquidity but in doing so it needed to be very clear that it was suspending any belief in free markets.

The moral hazard is clear but the implications have not been explored. On one hand the government wants to bail out private companies who are clearly responsible for their own position. At the same time they want to promote policies like privatisation because, wait for it, private companies are more efficient than public ones.

It’s very clear that the neo-liberal dream is in tatters but no one seems to want to wake up and smell the reality. Market morality is indeed quite hazardous.