“Capitalism without Financial Failure is Not Capitalism at All”

Jim Grant with a very worthwhile read in this yesterday morning’s NYT: The Fed’s Subprime Solution.

Grant notes that credit boom and bust cycles "have occurred in every institutional,
monetary and regulatory setting," and (correctly IMO) places the blame on the "human race, first and foremost. Well-intended public policy,
second. And Wall Street, third — if only for taking what generations of
policy makers have so unwisely handed it."

How does this manifest itself?

"Possibly, one lender and one borrower could do business together without harm to themselves or to the economy around them. But masses of lenders and borrowers invariably seem to come to grief, as they have today — not only in mortgages but also in a variety of other debt instruments. First, they overdo it until the signs of excess become too obvious to ignore. Then, with contrite and fearful hearts, they proceed to underdo it. Such is the “credit cycle,” the eternal migration of lenders and borrowers between the extreme points of accommodation and stringency.

Every crackup is the same, yet every one is different. Today’s troubles are unusual not because the losses have been felt so far from the corner of Broad and Wall, or because our lenders are unprecedentedly reckless. The panics of the second half of the 19th century were trans-Atlantic affairs, while the debt abuses of the 1920s anticipated the most dubious lending practices of 2006. Our crisis will go down in history for different reasons.

One is the sheer size of the debt in which people have belatedly lost faith. The issuance of one kind of mortgage-backed structure — collateralized debt obligations — alone runs to $1 trillion. The shocking fragility of recently issued debt is another singular feature of the 2007 downturn — alarming numbers of defaults despite high employment and reasonably strong economic growth. Hundreds of billions of dollars of mortgage-backed securities would, by now, have had to be recalled if Wall Street did business as Detroit does."

The end game has yet to be written. However, it may not be a replay of the 1990s. Grant suggests that Bernanke is not the same sort of Central Banker that Easy Al was:

"Now comes the bill for that binge and, with it, cries for even greater federal oversight and protection. Ben S. Bernanke, Mr. Greenspan’s successor at the Fed (and his loyal supporter during the antideflation hysteria), is said to be resisting the demand for broadly lower interest rates. Maybe he is seeing the light that capitalism without financial failure is not capitalism at all, but a kind of socialism for the rich."

 Joseph A. Schumpeter would be proud . . .


The Fed’s Subprime Solution
James Grant
NYT, August 26, 2007

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What's been said:

Discussions found on the web:
  1. D. commented on Aug 27

    But it’s been SOCIALISM for the last few decades yet Americans have never been more convinced they’re witnessing capitalism! Governement interference has been huge!

  2. Philippe commented on Aug 27

    A journey throughout the capitalism system from Ponsi to Minsky and a temporary halt with Schumpeter.
    These journeys are consumming credibility and the new Fed has to restaure it, for the country’s sake and not for Wall street which has demonstrated that it can live well without it.

  3. erik commented on Aug 27

    what is truly scary is that the markets are much more powerful and unbridled than we care to suggest. it’s much like a force of nature in that you may think you can sufficiently warn those in peril or protect yourself against the elements, but when mother nature comes knocking you are completely at her mercy.

    levees have been built, sandbags have been set and lifejackets are all on. problem is if it’s a catagory 5 storm they are all worthless and destroyed in the first twenty seconds.

  4. km4 commented on Aug 27

    US could be heading for recession

    Former US Treasury Secretary Larry Summers warned that the United States may be heading into recession as the biggest victim to date of the sub-prime mortgage debacle…

    “It would be far too premature to judge this crisis over,” Mr Summers said. “I would say the risks of recession are now greater than they’ve been any time since the period in the aftermath of 9/11.”

  5. blackvegetable commented on Aug 27

    Jim Grant just doesn’t get it……

    This is not a “top down” crisis, it is a “bottom up” one….

    As I have argued, and this page has demonstrated for some time, claims of job creation and “strong growth” are arrant nonsense….Private sector job creation has been miserably anemic, in the range of 3.5 million since Jan 2001. GDP growth has lagged well behind the 35 year average. Taking only the “peak” of this economic cycle, we have seen growth at levels BELOW those of the “Malaise Years” – in spite of tax cuts, deficit spending and Fed Reserve largess. One is left to wonder why Grant insists otherwise.

    If labor markets were as healthy as Grant insists, we would see upward pressure on wages, which have failed to grow in real terms since 2001. We would see the participation rate increasing, but it has, in fact, contracted by a full percentage point – the nominal equivalent of 1.3 million jobs.

    It is here that the economic rubber hits the road. The liquidity crisis doesn’t arise from Wall & Broad, it is the reality of individual households which have been obliged to scavenge their savings, tap into their home equity, and exhaust their credit, solely in an effort to hang on. For an enormous number, the string has run out.

    To add to this misery, the Federal Government has “spent forward” any and all resources which MIGHT have served to ameliorate the situation. There are real economic consequences attendant to pouring 12 billion dollars per month into the effort to salvage Junior’s legacy in Iraq. In this case it is hamstringing the Feds, leaving few, if any options to address the crisis.

    When the toll from our last experimentation with “supply side” was measured, the Feds found themselves obliged, for fear of a cratering labor market and economy, to extend unemployment benefits. Will the Feds determine this time to temporarily assume peoples’ mortgage obligations?

    Competence at the top really does matter, Jim….

  6. ari5000 commented on Aug 27

    I thought capitalism was about BUILDING something — a business, a service, a new idea…

    What has become the largest sector of the S/P 500 is nothing more than paper shufflers by a bunch of guys who take a big %age of the pie when it’s all done.


    BR: I don’t have any problem with creating something that is based on Intellectual Property.

    The problem isn’t the paper shufflers — its how BADLY they shuffled that bad paper, pricing it incorrectly and failing to recognize the attendant risks.

    If you are going to create intellectual property, well, then, it better stand up to close scrutiny . . .

  7. wally commented on Aug 27

    Bernanke speaks on Friday. We’ll see.

  8. The Financial Philosopher commented on Aug 27

    Capitalism brings the best and worst of what America has to offer… What I find interesting is that we are driven, often fatally, by the desire to find the answers to the given questions of the day. The human tendancy to seek out patterns, for better or worse, will never end — and neither will the cylce of greed…

  9. Ross commented on Aug 27

    Capitalism to me is just another ism. It is a function of our Western infintessimal mathmatic. It’s the only game in town and must be played by OUR rules. To my amazement, the rest of the world has adopted this system. Eventually another system or ism will prevail. It is like the difference between money thought (finance) and pieces of money (coins, bills etc.) Yet I too see the current excesses and sense we are entering the ‘slough of despond’.

  10. KP commented on Aug 27

    Capitalism is fundamentally flawed. It is failing now as it always has, and always will. Just as pure communism is a failure, so to must the opposite be. Socio-economic balance is not achieved under either system. A compromise must be reached, and we ain’t there yet.

  11. tom c commented on Aug 27

    KP- Your logic is flawed. Capitalism is a descriptive word that merely categorizes the kind of economic activity that tends to exist under a particular legal structure. Where there are limited, constitutional government, property rights, contract enforcement and the generally free movement of goods and services, what you call the ‘ism’ of capital will tend to exist. Capitalism is not imposed, top down, like social/statism, it’s roots are organic and grow naturally out of the legal system. It comes down to priorities: If ordered liberty, in the sense of classical liberalism, is the system under which we prefer to live, then ‘capiatlism’ will exist as well. American’s don’t live under ‘capitalism’ when the public sector consumes what it does of the productive capacity or regulates the economy to the extent that it does. American’s live under a mild form of social/statism and an administrative state that’s as flawed as the human beings that populate the bureaucracy.

  12. Kondratiev commented on Aug 27

    blackvegetable…riveting commentary

  13. Jim commented on Aug 27

    No other system has incented the advances in food, shelter, healthcare, and standard of living, but still we complain. Maybe that’s the problem – so many people who would otherwise not be alive right now if it weren’t for capitalism are over-consuming resources and draining entitlements?

    Has anyone seen the credit stats of prime mortgages lately? I just don’t see the carryover/meltdown.

  14. HealOurWaters commented on Aug 27

    There is a coalition coming out with an economic report in a couple weeks showing that cleaning up the Great Lakes will turn out to be CHEAPER in the long-term. Take a look at the site:

  15. REW commented on Aug 27

    This has nothing to do with capitalism. The FOMC by definition is anti-free market (the idea that 17 academics know better than the millions of market participants is laughable).
    The Fed’s experiment with the Federal Funds Rate Target mechanism has been a resounding failure. It is time for the Fed to abandon the Keynesian concept that growth causes inflation (they are the last holdouts) and focus on market-based measures of inflation.

    The pain that the “moral hazard” crowd wants Bernanke to enforce is not the fair result of capitalism. It would be the result of previous Fed errors. There was no reason for the Fed to take the FFR from 1% to 5.25% (other than the fallacy that growth causes inflation). Those actions lead to slower growth at the margin and turned many prudent investment decisions into failures. The Fed caused this mess by hiking rates unnecessarily and they need to act to clean it up and then abandon their FFR target regime.


  16. michael schumacher commented on Aug 27

    Black veggie-

    I have asked the wage question numerous times to people here and those who “write”.

    Apparently that is what is “different this time”. I don’t buy it.

    I stand by my original post. With all these wonderful jobs and the employment rate that never seems to show any growth in unemployment yet we continue to show NO growth in wages because that would show the one thing that this Fed/administration does not want: Inflation.

    Can’t show inflation because they are busily re-defining it almost with every word they speak about it.


  17. wunsacon commented on Aug 27

    >> Governement interference has been huge!

    In the case of this housing bubble, private industry elected to make bad loans. They wanted the HUGE short term fees. As many privately say, they KNEW they were making bad loans.

  18. Suresh commented on Aug 27

    Mr. Grant said, “Ben S. Bernanke, Mr. Greenspan’s successor at the Fed (and his loyal supporter during the antideflation hysteria), is said to be resisting the demand for broadly lower interest rates.”

    Who says this?! By cutting the discount rate, Dr. Bernanke has already shown that he can’t resist the demand. The pundits yammer about the discount rate being a symbolic rate. But, at least at this time, it isn’t. Cutting the Federal Funds Rate wouldn’t do any good because banks are afraid to loan each other money and receive commercial paper of unknown value as collateral.

    The Fed may well be in a box, but now that Dr. Bernanke has cut the discount rate, he is forced to go all the way and crank the Federal Funds Rate and the discount rate, if need be, back down to 1%. Raising rates to combat a rising consumer price inflation rate will only weaken the confidence of market participants.

    What do you guys think?

  19. Charles Buterl commented on Aug 27

    I suppose it is because ‘socialism’ is mostly understood as a perjorative in the U.S. – along the lines of ‘pederasty’ – it is not surprising that contributors like Tom C. seem to think it synonymous with ‘statism’, although this latter may be essential to a functioning socialism. As for capitalism evolving from the bottom up through the legal system (be this as it may), the equally valid assumption that the benefits will accrue equitably from the top down may no longer apply in an economy that becomes more and more based on the manipulation of capital, rather than its being put to use in production. A more realistic taxation system (the favourite of pederasts worldwide) might go some distance toward rectifying this.

  20. KP commented on Aug 27

    I don’t know so much that my logic is flawed more than my definition of capitalism differs from your own.

    To me capitalism, as I understand it(whether it is right, wrong, jives with the classical definition or not), is defined as the act of money flowing where it profit arbitrage exists. I say that it is flawed in that these profit arbitrages have NOTHING to do with the interest of the common good. People get into a business to make money, not because it is in the interest of mankind(Ex. CDO’s!)

  21. mike e. commented on Aug 27

    I don’t see this issue as being a test of capitalism or socialism – that is far too big picture for me.

    I prefer to think of this as being test of solvency and recession avoidance.

    The headlines that I have read indicate that there has been plenty of failure.

    Jim Grant may want to read Bill Gross’ September release.

  22. W.Edwards commented on Aug 27

    Funny how the William Pesek opinion piece on Bloomberg also makes reference to “financial socialism” today. Sounds like there’s a new buzz-phrase floating around the financial press rooms these days.

    KP, I agree with tom c in that your take on this is wrong. The main problem with capitalism (or any financial market model for that matter) is that it has to fit within a social/legislative/monetary framework created through political concern (as well as political pandering) that often creates perverse financial incentives which wouldn’t have occurred otherwise. True, greed perverts the capitalist system. However, greed is an inherent human trait that cannot be suppressed regardless of the system in place. All forms of government and market systems have had political and financial leaders that profited unjustly from the common man. The difference with capitalism is that the common man has a greater degree of participation and control within the system than under other forms.

  23. D. commented on Aug 27

    Capitalism is when the market rules, including interest rates and bankruptcies.

    The Fed determines rates so having a Fed is Anti-capitalistic. In capitalism all rates should be determined by the markets.

    Pure capitalism lets the market clean itself out. Bailouts are anti-capitalistic. K-Mart coming out of Bankruptcy protection and buying up Sears is a perfect example of capitalism run amock

  24. ari5000 commented on Aug 27

    this whole economy does not run on capitalistic theories anyway…

    If the U.S. were a business, it’d be bankrupt.

    If homes hadn’t gone up in value for 40 years, most Americans would be bankrupt.

    If most mortgage co’s and hedge funds had to fairly valued their securities, most of them would be bankrupt…

    We need a new term for a society that runs on debt.


    Everything that is made, is made in China by people being paid 25 cents an hour… Honestly, I think our economy has a lot more in common with medieval feudalism than anything else.

  25. Estragon commented on Aug 27


    Your definition of capitalism is flawed.

    It has nothing to do with profit arbitrage, but is an economic system in which the means of production are privately owned.

    D – “Capitalism is when the market rules”

    Not necessarily. State owned enterprises may operate by market principles, but you’d still have a socialist economy. Likewise, you could have all means of production owned privately, but the market eliminated by royal charter, letters patent, etc.

  26. KP commented on Aug 27

    To me…capitalism is synonymous with greed.

    In the ideal sense it is not, I understand that.

    But the meaning that is found in books has never existed in the real world, and is less valid to me than my own observations.

  27. jkw commented on Aug 27

    I read an article in the local newspaper today that said unemployment is low enough in the mountain west that wages are being pushed up. They interviewed a McDonald’s franchise owner who had to raise pay to $10/hour to get enough employees. It looks like at least some parts of the country are having wage pressure from low unemployment.


  28. KP commented on Aug 27

    I just wanted to say thanks to all for your responses to my comments.

    I come here and say what I think, in the interest of learning something new everyday, and making corrections to those things that I thought I knew.

  29. KP commented on Aug 27

    To jkw’s point:

    Wage increases have happened in both isolated pockets(Oil Field for sure) and on a broader basis….Minimum wage has been increased? Right?

    But does anyone think that Wages have kept up with actual expense inflation? I sure don’t!

  30. kckid816 commented on Aug 27


    do you think that the fact that the Micky d’s is in Montana has anything to do with it? It’s already a rural sparsely populated state. I think wage pressures there would be vastly different than say California, New York, Texas or any populated urban environment.

  31. michael schumacher commented on Aug 27

    here’s another wrinkle in the wage pressure thing. Most service business’ are in the process of or have already lost there summer help. In order to keep it going they will almost have to raise wages to attract workers that are not used to working for a short time period (students=cheap labor).

    Now I’m almost positive that sort of gain in wages will be reported as “real” however how much of it is because there is a shrinking amount of workers available every August/September or is it spun so that it is shown as a real wage increase happening in tandem with our “tight labor market” that we continuously get shoved at us.

    We have seasonality in our low paying jobs in a big way……how much of that seasonality will be used to show wage increase that is temporary at best?? I gather it will be much in the same way that the BLS STILL adds almost 43K in construction jobs just because it is seasonal in nature…..

    Something to think about as we get reports of “wage increases” for the next month or so. Seasonality has ALOT to do with it.

    Financial Firms are laying off……..that is what i call anaethma to a bull market.


  32. Cherry commented on Aug 27

    That is not Socialism. Hence, stop using that utopian term. I don’t see equality(hence the end of all government by dreamers).

    It is called “Oligarchy”.

    2nd, the FED is a private bank. It isn’t a part of the US government. I can’t believe people still fall for that lie.

  33. VJ commented on Aug 27

    capitalism without financial failure is not capitalism at all, but a kind of socialism for the rich

    Nothing new about that. Socialism for the Rich & Corporate has been in overdrive in this country since 1981. Income mobility between generations has been falling since the radical change to our tax system in the early 1980s, whereas in prior decades to that it had been rising. Now, most children of rich parents stay rich, and most children of the poor stay poor. This is in stark contrast to nations such as Canada, France, and Germany, as well as to our nation’s own history prior to the shift to failed RightWing economics in 1981.

  34. D. commented on Aug 27


    cap·i·tal·ism /ˈkæpɪtlˌɪzəm/

    n. an economic system in which investment in and ownership of the means of production, distribution, and exchange of wealth is made and maintained chiefly by private individuals or corporations, esp. as contrasted to cooperatively or state-owned means of wealth.

    n. An economic system in which the means of production and distribution are privately or corporately owned and development is proportionate to the accumulation and reinvestment of profits gained in a free market.

    n. an economic system based on private ownership of capital [ant: socialism]

    Capitalism is THEORETICAL just like communism. They are both ideals that have never been practiced according to their true definition or principles.

    Your argument is moot, as soon as you have a state owned corporation you DO NOT have capitalism!

  35. Pat Gorup commented on Aug 27

    VJ: “Socialism for the Rich & Corporate has been in overdrive in this country since 1981.”

    You are right! Reaganomics ushered in supply side economics which according to Paul Krugman was “a smokescreen for politically-motivated tax cuts”. David Stockman added that the Kemp-Roth Tax Cut “was always a Trojan horse to bring down the top (marginal income tax) rate”. The arguement for supply side economics was; that benefits would “trickle down” to poorer Americans. It has been a concerted effort, since 1980, by this Government to effectively eliminate the middle class as we know it and they’re doing a good job. Take that Kudlow…

    Speaking of which, I found myself watching his show today and he now believes that a FED rate cut would actually strengten the dollar. Who knew?

  36. mhm commented on Aug 27

    I think the issue here is not whether capitalism is flawed or theoretical only.

    The failure we see today (or any other time in the history of capitalism/socialism/whatever social organization concept) is an Ethics issue. Corporate and personal responsibility is the weakest link. Power/money corrupts. That is being discussed over two thousand years and we clearly don’t have a solution yet.

  37. Pat Gorup commented on Aug 27


    I believe that most would agree that the idea of a people-oriented democratic run government does not work. I also believe that most would agree that the idea of a people-oriented socialistic run government does not work either. However, they both have their good points and eventually the best principles of each will blend together and create a “goldilocks” type government. I won’t be around but if I were, I’d move there in a heartbeat. Ethics is a learned value and the only value that I have seen in our leaders, corporations and citizens for a long time now…is narcissism.

  38. Greg0658 commented on Aug 27

    2 of 6 lines of the Jaycee creed:

    That economic justice can best be won by free men through free enterprise;
    That government should be of laws rather than of men;

    I memorized that creed and believed it.

    IMO – graduated flat style tax with no riddlesome loopholes.

    The more you make the more you pay to the system that is making you wealthy. Not burdensome to anyone class. At the top end of wealth creation, the tax climbs by the same rules, but begins to influence companies that maybe its time to hold the present course, not try to take it all, and leave something for others.

    Face it all you would be capitalist entrepreneurs – robotic productivity and conveyor lines has made successfull startup from scratch very difficult. Odds are high that your opponent will defeat you.

  39. Winston Munn commented on Aug 27

    The wage pressure issue should be no surprise as the employment base has expanded worldwide; if the wage pressure becomes too great the jobs are exported, leaving service positions in their stead.

    This concept of a rising tide that lifts all boats is erroneous. It is not a rising tide but a flood, caused by the collapses of the job dams in industrialized countries. What a flood does is seek equalibrium, lowering the level that was once behind the dam while raising only the levels in the lowlands.

    The only ones left untouched are those who always have stood high above the waterline.

  40. Lord commented on Aug 28

    Who really thinks a Fed cut would prevent financial failure? The most it could prevent would be economic failure.

  41. tom c commented on Aug 29

    Lord- You make sense. A rate cut won’t increase the value of bad mortgage paper. Might make the market for this sludge a little more liquid but that’s about it. Credit standards are changing for the better and lending should return to more traditional measurements of credit worthiness. How is that bad?

  42. The Big Picture commented on Aug 31

    Major Policy Shift — or Politics as Usual?

    Over the past few weeks, market’s have been rather volatile, swinging wildly between triple digit gains and losses, closing at the highs and lows of the day. The sub-prime debacle, the credit crunch, the liquidity situation — all turn out to be pressu…

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