Sunday, November 02, 2008

Libertarianism R.I.P.

An interesting little debate between Jacob Weisberg in Slate and
Richard Epstein in Forbes on the “Death of Libertarianism”, HT to my mates at ALD.

Each has their own little hobby-horses which to trot around the stage and play at jousting in the lists.

On the subject of the causes of the “current” collapse of the financial and banking systems, there is as might be expected considerable difference of opinion.

Epstein, predictably, blames government involvement and interference –
Alas, the financial rot started in the underlying home-mortgage market, with the government decision to subsidize home mortgages generally through low interest rates, and compounds the problem by offering special Fannie and Freddie guarantees at the low end of the market.
These foolish decisions prompted market actors to react just as libertarians fear: to profit privately from public foolishness. Savvy lenders looked less to the creditworthiness of their borrowers and more to unwise government guarantees that insulated them from risk. A high-risk loan of $1,000, without that guarantee, could be worth half that sum before the ink was dry. But who cares, if a government agency will pick up the slack?
Similarly, self-interested borrowers eagerly grasped at cheap-money loans, thereby driving up the price of underlying assets. But once these subsidies became too expensive to sustain, the capital markets raised the price of interest, which killed off refinancing for persons living beyond their means.

All of that is quite true, and quite logical. I am not going to argue against it.

Weisberg lays his “cause” like this –
Perhaps the most alarming moment was the failure of a giant, superleveraged hedge fund called Long-Term Capital Management, which threatened the solvency of financial institutions that served as counter-parties to its derivative contracts, much in the manner of Bear Stearns and Lehman Bros. this year. After LTCM's collapse, it became abundantly clear to anyone paying attention to this unfortunately esoteric issue that unregulated credit market derivatives posed risks to the global financial system, and that supervision and limits of some kind were advisable. This was a very scary problem and a very boring one, a hazardous combination.

Those with memories might dredge out the graphic I stole from Herald back in September; the inverted pyramid of the “money supply”. Weisberg I think could well have included that to illustrate his point.

I have to say that my views are no more valid than either of these august gentlemen. I balance that by admitting that in terms of erudition and learning they probably stand a few miles ahead of me.

I think that both these jousters are correct – in the small and very specific parts of the overall train of events that they have presented to support their respective views. That, I submit, is the danger of taking both of these gentlemen at face value and in isolation.

So, when Epstein says
” At this point, securitization, which diversified some risks, accentuated others by spreading the bad paper throughout the entire system. Now the high default rates on mortgages introduced massive uncertainty for valuing these financial instruments, which triggered government mark-to-market re-evaluations--which in turn forced a premature liquidation of assets. And presto, the failure of the Wall Street investment banks mushroomed into a larger financial crisis.”

...he is right on that thin edge of untruth. It is a matter of regulation in most markets – regulation set by the markets themselves and by the participants – that many different contract forms must be regularly, and as regularly as daily, revalued (mark to market) and the difference if negative lodged with the market. That is practice, and not something that “the government” suddenly undertook, and which he implies caused the collapse. Yes, it is likely that mark to market pressures were a major partial cause. But that was likely as a result of traders not being able to obtain the readies to lodge with the market as practice and convention required.

In my view the reality is that there was little that any government could have done to prevent the collapse of the banking and credit systems. So much of the system is based upon the fundamentals of fair dealing, of personal and commercial trust, of open and honest trading that regulation was (and still will be) an impossibility.

For that very same reason, the future control and regulation of the credit supply will continue to be at the hand of commercial practices and market convention rather than by government control.

Despite that midpoint conclusion, and to balance the number of times I quote the two protagonists, I do like Weisberg’s conclusion
The worst thing you can say about libertarians is that they are intellectually immature, frozen in the worldview many of them absorbed from reading Ayn Rand novels in high school. Like other ideologues, libertarians react to the world's failing to conform to their model by asking where the world went wrong. Their heroic view of capitalism makes it difficult for them to accept that markets can be irrational, misunderstand risk, and misallocate resources or that financial systems without vigorous government oversight and the capacity for pragmatic intervention constitute a recipe for disaster.

As I have said before – the perfect system will fail, because humans are involved in its operation.

1 comment:

Al said...

Your comments are wiser than Weisberg's.