A thought on Capitalism

Conventionally Capitalism is viewed as “an economic system” or the system that is used to produce and distribute “privately or corporately” acquired profits through a free-market (dictionary.com). This basic definition illustrates the notion of capitalism is based on the individual needs– if an individual is able to make profit they are a winner - if they fail to make a profit then they are without stance. The fundamental rules of capitalism would appear to support Greenspan’s view the ‘foundations’ or the structures that make up the financial system are the root of the crisis by conveying a system that fuels individual wealth and gains rather than considering the wider society. This argument would appear to have a consensus among other scholars, such as Immanuel Wallerstein (1997) who vindicates capitalism interest lies in “making profit” rather than “defending a free market.”

 

In 2008 the global financial system was in serious turmoil since the great depression of the 1930s which bought into many minds whether the current financial system was adequate for the 21st century and beyond or an alternative system is necessary to avoid such economic instability. The prominent business oligarch Alan Greenspan described the financial crisis as being ‘once in a century credit tsunami.’ (GIF Magazine, 2010)

 

It is debateable whether this financial crisis is a one off or another crisis may happen but it is evident that shaken financial policy-makers are not risking stirring another crisis of this sort. According to Greenspan the crisis has “shaken the very foundations of the capitalist financial system.” 

 

The argument against Capitalism

Wallerstein‘s (1997) view that capitalism is further strengthened by Kindleberger (2005), who illustrates the turmoil and failure of the Capitalist system through the 2008 financial crisis. He boldly states the capitalist system allowed ‘irrational exuberance’ and the engorging of financial bubbles leading to the financial crisis.

 

If Walsterstein’s and Kindelberg’s idea that capitalism is a tool for ‘irrational action’, it may be argued that capitalism has in fact indoctrinated a fallacy that maximum profit is the driving force for an individual and it is this belief that drives individuals and organisations that operate in today’s markets – some may come to the conclusion that capitalism in-fact nurtures greed in people. This argument is taken a step further by Panayotakis (2010), who mediates capitalism is not only seeing the few getting rich which he brand as the ‘elites’ but also the recent financial crisis ‘exposes’ the incompetence and corruption of the entire system (Panayotakis, 2010).

 

The belief that Capitalism somehow nurtures greed is further strengthened by Alvin (2010) findings during the property boom – banks were lending money to people blindly forgoing any credit checks or ensuring the people lending to could afford to repay the high interest payments. The aggressive nature of the banks to lend money during the property boom illustrates the underlying value of a business is profit driven no matter the risk that are involved. The profit culture is further evident when banks diversified the risks by securitizing these mortgages into derivatives like ‘Collateral Debt Obligations’ and buying Credit Default Swaps (CDS) from insurers. Banks like Lehman Brothers were borrowing more and more money to invest in mortgage-related assets. Their debt gearing increased from 21:1 in 2003 to 34:1 in 2007 (Alvin, 2010).

 

Chapra (2008) points to the cult like obsession of ‘excessive lending’ leading up to the financial downturn with banks following artificial rise in consumptions and speculative investment. He confides this was as a result of the ‘materialistic’ culture whereby wealth and profit are determining factors of success (Chapra, 2008).

 

Stewart (2009) at a visit to the London School of Economics asked why economists’ failed to foresee the crisis? The response to which was “people were doing what they were paid to do, and behaved according to their incentives, but in many cases they were being paid to do the wrong things from society’s perspective.” (Heather Stewart, 2009)

 

This, according to Gamblin (2009) has bought into contention the legitimacy of capitalism as a viable financial system – the illegitimacy has been illustrated through one of the worst financial crises and political collapse in history (Gamblin, 2009).

 

The argument supporting Capitalism

Although expressing the opinion that capitalism as being a system that fuels greed and elitism, without considering the whole matter would be irrational in its own right - as the success and failure of capitalism is subjective. For starters, a capitalist system is best suited is within a free market has undeniably encourages the idea that everyone starts from a level field and creates an environment of competitiveness. The competitive nature is encouraged throughout the world communicated as a necessity to prevent cartels and monopolisation of markets. In Europe the European Commission has a special DG Unit specifically enforcing competition rules across EU states, while in the USA there is a special unit monitoring to ensure markets are competitive. This allows for everyone to have an opportunity to produce and distribute equally preventing from a single individual or corporation from having a dominant share of the market and price fixing (European competition commission, 2011). If indeed, capitalism was the source of a competitive market it would be rhetorical to suggest that it somehow creates greed because if that was the case, then it would support the creation of cartels and monopolies within the financial institutions.

 

Further to the above, Chapra (2008) also highlights the ‘active role’ the financial institutes played in the faster than expected development of the world economy. He emphasises this was due to the financial innovations and the technological advancement in information and communications technology. He solidifies these arguments by identifying these factors as the key pawns in the economic development. Although he also emphasises the current ‘system’ is plagued by “persistent crises” (Chapra, 2008). The crucial role the financial system has played is significant and needs to be acknowledged that without a financial system – economies would not have been able to develop into the maturity and through ‘innovation’ has enabled exponential growth within a short period of time.

 

It would seem counter-productive, to point fingers to a capitalist system for the financial failures as like anything in business, they all come with a certain amount of risk and likelihood of failures. Instead it would seem far more reasonable to acknowledge the benefits of the current financial system such as growth of the world financial markets, although due to inadequacies in monitoring the system has caused a mirroring effect in terms of the negative impact it has globally which is apparent through the 2007 financial collapse. It would be fair to comment this report is not trying to establish the blame of the problems but identify some of the key issues that lead to the crisis.

 

Schumpeter (1947) views capitalism as a “method of economic change” that is “evolutionary”. He argues capitalism allows markets to evolve through a process he defines as being “creative destruction.” It may be viewed as being a radical suggestion, but his logic seems apprehensible – by taking the financial system to destruction it is then possible to identify the weaknesses of a system and rebuild the structure eliminating or at least limiting those weaknesses (Schumpeter, 1947: 82). In 2009, The Economist magazine would appear to support Schumpeter’s initial opinion that a crisis is an opportunity for new entrants into the market to make gains while the big players take time heal from the mistakes (Economist, 2009). Although the consequence of such financial meltdowns would present both Schumpeter’s radical opinion under severe contention and would certainly struggle to push financial policy makers to accept that such a financial crisis should be accepted as part of the norm.

From ‘Aristotelian’ point of view, the economic crisis was a portrait of the moral failings of the financial system and infatuation with wealth creation for a few but in the name of many. The consequence of such moral failings present a real challenge within a contemporary financial system as it would be extremely challenging to overcome the addiction of wealth (Nielsen, 2010).

 

Instead, it would appear most experts prefer to fault the current system as having components that are floored and require re-adjustment. Immanuel Wallerstein (1997) considers the current financial system as being a ‘betrayal’ to the very fundamentals of capitalism. Rather, he vindicates the bail-out package endorsed by the two presidents of the USA, George Bush and Barack Obama as being “ersatz” of the true system. Panayotakis, 2010 supports this and views the current financial system as rewarding private individuals without any ramification for their high risk gambling while endorsing the losses in a social process whereby it is up to the greater society to bail them out.

Concluding comment on Capitalism

The author of research argues that Capitalism is a principle that allows the power of balance to favour markets over society and this is evident in many ways. First, the principles of free -market are adopted within current financial operations by not allowing cartels and monopolies to exist. In doing so, a free market allows those within the financial market to have a fair share of the market. This allows for equal distribution of wealth in certain respect, in that everyone has access to the wealth through the free market. Although by creating a free market also creates an ambience of ‘competitiveness’ which drives people to push for wealth and want to achieve without boundaries in order to be the best. It is this idea of competitiveness which is the moral principles underpinning capitalism with blind implication for wider society that displaces capitalism from being something that is humanistic to something that is purely wealth orientated. By purely focusing on market forces strengthens the argument that the financial system is a capitalist one which may implicate it for being the pre-cursor of the financial downfall.

 

Second, the time leading up to the financial crisis banks were allowed to lend with no concern to the consequence of their action and due to disregard to their actions led to the financial meltdown. It is argued by many authors the reasoning for such incompetent actions was to gain maximum profit. This argument would appear to be plausible and it may have been due to greed, however, the root of this greed for profit, seems to be from a competitive environment whereby banks were competing to be at the top of their industry which seems to stem from the capitalist ideology of free markets. Although the author accepts that free-markets are better than controlled markets, the financial downturn presents a paradox, too much freedom would seem to present recipe for disaster while lack of freedom would stigmatise growth i.e. profit.

Third, the idea of changing a financial system was only a suggestion after the crisis - this would again suggest the power of balance is with the financial institutes and they seem to determine the outcome of their own fate. Prior to the crisis in 2008, governments and policy makers were happy to turn a blind eye on any contentious issues relating to banks – because they were providing huge profits from which people were able to enjoy a over welcoming life style. In which case what appears to be happening within a capitalist system, is that through a free market an ideology of wealth as being the most important factor in society. In turn a capitalist society would seem to shift impetus to wealth as being the most important factor and this in turn has created an environment of greed. However, whether the creation can be placed on the Capitalist ideology is questionable, and instead it would seem more plausible to suggest that it is the individual who has the choice to determine the outcome of their decision. However, the capitalist system does create a certain hierarchy of markets making those within the financial industry feel as though they are the power makers and they are the most significant within society. Within a moral context, capitalism would seem to generate a society that is interested in wealth while other factors seem to be dismissed. For example, Although if this argument is developed a stage further, banks fail to take on any moral responsibility when it comes to transactions, rather they would seem to be more interested in the financial gains with no real interest to help the borrower to maximise their business potential. This is illustrated through the sub-prime instruments whereby huge loans were given with no real checks as to whether that individual was able to make repayments on the agreed schedule. While at the same time, the banks were more interested in selling these products to make a ‘quick buck’ due to the very competitive market environment at the time.

 

Although much of the arguments suggested in this section have been vindicating the financial system, the real crux of the issue appears to be with individuals taking decisions. It can be argued that a certain amount of pressure is beamed upon them to gain maximum profit but ultimately it is the individual’s morals and decision to act upon those pressures. The next section focuses on the human aspect of the crisis and explores how much of an impact the individual had on the crisis within a moral and practical context.

 

The Human aspect of the crisis

The political definition of capitalism would shift the impetus of the cause of the financial melt-down from the financial system to the individuals or people as it emphasises the financial system as being a social system based on the “principle of individual rights.” This downplays the notion that the capitalist system is responsible for any irresponsibility and instead suggests that individuals decide upon the fate of their decisions. The capitalist system is merely providing a platform from which competitiveness and free-markets can co-exist within a society that demands wealth. The free-market actually allowed individuals to participate within a free market and through their innovation and determination have the opportunity to gain financial wealth. If the political definition is applied in context to financial crisis it could be assumed that it was due to an individual’s wrong decision that was the root of the problem. This in turn, as Walden Bello says “we have to pay for the sins of the past”, sin being greed of the individual wishing to gain wealth at the cost of others (Walden Bello, 2008).

 

The idea of individual greed is further palpable by Paul R La Monica 2008 who considers the behaviour of the financial decision makers which he labels as the ‘financial geniuses’, he convenes that ‘the temptation’, especially during a financial bubble is so great that these so called geniuses cannot resist to take risky decisions to gain more wealth and this is apparent throughout history.

 

This greed and the addiction to wealth is further apparent with ordinary citizens, for example in the USA, Americans were competing against their friends and relatives who were moving into bigger houses - coupled with available cheap loans, they were borrowing to own homes they could not afford. As a result, many poor citizens were stretching themselves with subprime properties (Alvin, 2010).

 

“Sub-prime mortgage is a loan to a borrower who have a default credit rating or who do not qualify for ordinary market interest rates. This may be because they have been bankrupt or have a bad credit history. Borrowers who normally fall under these categories are required to provide additional collateral for loans and face higher interest rates.”

 

The principle of having a sub-prime system is to allow people the opportunity to acquire credit based on trust which is mutually acknowledged between the borrower and lender. This principle appears to be blindly accepting high risk without any real assurance that payments of the loan shall be met. This brings serious contention as to why such transactions were able to be traded on the wider stock exchanges with limited guarantee on the returns. This behaviour puts certain questions on who is responsible for such transaction, on the one hand it can be easily said that the bank has overall responsibility for all transaction and it is up to the financial institution to take responsibility for such illicit transaction. However, on the other hand, the complex nature of financial trading it would be an impossible task to check all transactions when they are happening and this paradox shifts the emphasis of responsibility on the individual who would appear to have control of the transaction that is happening. If this is the case, then it could be argued the individual holds the realms of gains and losses for transactions and it is due to their decision which determines the outcome.

 

Although Sub-prime products allowed people the opportunity to have their own property with the opportunity to establish them within society even though they may have been unlucky with their financial handling in the past. In essence the sub-prime loan objective was to allow people who were normally ousted from gaining loans to enter the market allowing them a second life. This illustrates the difficulty in trying to establish the moral high grounds on these tools and the arguments for and against are wide and varied – but ultimately the root of the financial crisis was from the sub-prime market and this puts the ‘for’ arguments for such instruments to exist on the back foot and an opportunity to re-evaluate the moral standing on such financial dealings. In context with the human aspect, it is difficult to pinpoint the blame on an individual or the bank but it would seem both had a role in the collapse of the financial system.

Human Greed

It has been argued by EL-Khatib that Greed caused investors to buy complex structured products so as to chase high returns but without regard to what they were purchasing and little or no understanding of the risks. Greed also inspired the dealers and investment bankers to sell such products so as to reap the arrangement fees. Greed also motivated top executives to over-rely on poor financial risk models and to take on added risks. (El-Khatib, 2009)

 

Although, Satyajit das, 2010 suggests the financial sphere under which people operate creates an ambience of “fear” of missing out on opportunities to gain more profit and this is further fuelled through the competitive nature that is injected in the markets. However, he does not emphasise the financial system as the culprit of this state but instead dwells on an explanation which places the human greed under the spotlight. As an example of his ideology of greed, Das (2010) explains the principles of ‘Derivatives’ in Financial World which he labels as being the "Weapon of Mass Destruction" (P. 12). This is also supported by global business leaders such as Warren Buffet who said “due to opaque pricing and accounting policies in swaps, options and other complex products whose prices are not listed on exchanges” (Ayub, 2010), in essence the complicated nature and hidden format of credit default swaps makes it into a weapon and without proper technical knowledge of the financial market the consequence of using such instruments are high in risk. The very fact that individual had no hesitation in using the instruments suggests that greed had a lot to play with the decision taken to trade in derivatives.

 

Phelim Boyle and Feidhlim Boyle, 2001 also denotes derivatives in a double barrel quandary. On the one hand he depicts them as being “efficient tools for reducing risk” while in the other barrel they seem to accept that derivatives have “awesome capacity to increase risk through leverage” but displaces these risk manipulation tools because they are utilised for greed. In simple terms they argue derivatives are used to reduce risk stems from fear of loss while the motivation to take on large amounts and reap high profits is also based on greed. In essence they are not faulting these tools but rather the handlers of these tools appear to be the venom in the bite of the crisis.

 

A further indication of the greed is evident by the fact the risk attached to derivatives were identified a decade prior to the financial crisis – as Serres (1995) quoted derivatives were of the opinion" they are powerful but safe unless they fall into the wrong hands. Yet no precautions were taken ensure the safe handling and dealing of such financial instruments.

 

According to Posner (2009) humans are instilled with greed as part of their cognitive make up, a flaw which is apparent in all human psychology. If humans are susceptible to greed which is further argued by Usmani (2002) who argues despite humans having “vast capabilities” they are not without limits and are prone to errors – he emphasises that human reason can be infested by ‘desires’ and misguide them to taking a wrong decision. This would displace the problem of the financial from the actual instrument to the people who operate the financial system and explicitly acknowledges that human ‘error’ and ‘greed’ which will always be present in the financial system (Roane 2005).

 

It would appear that Roane (2005) assumption that human greed is present in the financial system would appear to have further support from Leo et al (2008) who describe ‘top managers’ as being aware of short-term gains (profits) too such an extent that they forget the risk element in their transaction.

 

Human Greed Vs Capitalism system

The above scholars present a strong case of human greed playing an instrumental part in the financial crisis. The human nature of trying to acquire maximum wealth has been labelled as being ‘greed’ yet what is surprising in all the human factors is that society played an important role in allowing these institutions and individuals to operate financial instruments that are high in risk for the very same reason as they label as being greed, the acquisition of wealth. It could be argued from the financial institutions their job is to make money through trading – and ultimately these trades have a certain amount of risk that is common in every investment or decision taken within the unpredictable financial markets. If it is accepted that humans are psychologically instilled with greed as argued by scholars such as Satyajit, Monica, M. Ayub and Boyle et al and many more it would seem sensible to have a financial system that is enforced through strict government regulation. Yet even post crisis it would appear a contradicting approach is still being mechanised with the lack of acting proactively implementing a legal framework that further restricts the introduction of high risk financial tools such as derivatives and securitisation – as it would appear that society enjoyed the fruits of the profit making markets without any criticism when it did not affect their own pockets.

It is difficult to place blame of the financial crisis entirely on human nature as there are many dynamics that can influence the market. The term greed appears to be a manslaughter term post crisis with no definitive evidence to suggest it was human error or failure of the capitalist thinking. What is concrete is the huge negative impact of such global crisis and the need to find a solution to the issues that may have been the root of the problem.

 

Regulating the banking system

The financial crisis has brought much contention as to which way the pendulum should swing in relation to regulating the financial world. As the conventional method of resolving and controlling the financial markets, the way regulation works plays an important factor in at least trying to find a solution. According to Howard Davies and David Green, 2008 explains the answer is “heavily contested” and an “intellectual” challenge. Regulated firms and markets are of the opinion that they are already “over-controlled.” In contrast, politicians and civil servants think there is too much scope of complete financial melt-down to avoid regulation, and too much evidence of investor detriment and unjustified enrichment on the part of financial sector professionals (H, Davies and David, 2008).

Davies and Green (2008) advocate the current ‘International regulatory system’ has provided financial stability in an ever changing environment in a relatively 'piecemeal' fashion. It is undeniable during the early part of this century saw huge market growth across most financial hubs with economies enjoying free-markets within a competitive environment allowing economies to enjoy a period of time free from ‘boom and bust’.

 

Although Davies and Green (2008) also acknowledge the current regulatory system is ‘inadequate’ to deal with the changing nature of the world and reforms are necessary to meet the changing environment in which the financial institutions operate. It would appear the real challenge seems to be finding a balance between discouraging unnecessary risk but encouraging enough innovation for fruitful results, this conundrum brings the topic of regulation into a complex sphere that brings discord in the financial regulatory community. It is commonly accepted bringing a rigid regulatory process would, if as Schumpeter’s suggestion that ‘capitalism’ is an evolutionary process, a slow death to an innovative and growing financial market.

 

Additionally, further problems are posed by Howard Davies and David Green (2008) who outline a two-fold problem in trying to establish a regulated banking system. First, in trying to define the ‘externalities’ – there are so many possible algorithm based phenomenon and externalities that can occur it would be extremely difficult to define and confine them to regulations.

 

Second, the parameters in which ‘intervention’ would be justified are partisan – under the current financial system, trades happen bilaterally and cross-border covering different legal systems and various regulatory bodies. Trying to merge such complex systems under a single regulatory system would be an extremely complex exercise with potentially limited or no fruit bearing results.