Government and Business, Panic and Rescue

The Sinking of the Economy

The US Senate has just passed a $ 700 billion rescue package to end the carnage on their stock exchanges, and consequently stabilising the credit contagion that has spread around the world. The US House of Congress, although divided, has also passed this package.

The conflict over support for the deal is profound; $ 700 billion will allow the US government to nationalise the banking sector. Does this mean that free-market capitalism has failed and that the future is state-owned enterprise?

The short answer is, “No.”

Only capitalism can unlock innovation. No government official or communist dictat could create anything is technologically innovative as the cellular phone.

Fifty years of state-directed economic growth left the Soviet Union with a society living in precisely the same situation, with the same life-expectancy and living standards, as they did in 1940. During the intervening 50 years, the capitalist US and Western Europe improved their standards of living faster than at any previous time in history.

The reasons why this market crash is not an end for capitalism is closely tied with the reasons why it failed in the first place. But the confusion that abounds makes it very easy for the South African government to justify the R 12 billion they have squandered on South African Airways since 2004. The government isn’t subsidising SAA’s incompetence, they’re rescuing them from a difficult market!

A person who is drowning needs to be rescued, but they certainly don’t need you to take them home afterwards, put them in a wheelchair and look after them for life. A freak wave may result in lots of people that need rescuing and a collective response to deal with the problem. It must, however, be a short-term intervention.

That this particular meltdown is partly the responsibility of those who need rescuing is something that needs to be taken into account later. Right now, if the banks are unable to offer credit it affects everyone. Small business owners who need to lend money against a contract to pay salaries today, households who need to use a credit card to tide them over till pay-day, even a government’s ability to collect tax revenue ... everything is in jeopardy.

However, don’t you worry, next year some time a large number of executives will be called to account for this fiasco.

How much of this was fraudulent behaviour, how much poor oversight, and how much weak legislation? Probably a bit of everything.

Fraud is difficult to stop and sometimes rises to the highest ranks of government. If someone is determined to steal then independent investigators, courts and auditors are the best solution. However, the question of poor oversight and weak legislation require careful scrutiny.

The companies involved in these clever credit transactions are now so large that it is difficult for any one person to have a clear understanding of everything that happens in their company. The solution to the crisis – allowing some banks to buy their rivals and so create even more gigantic banks – compounds the problem and creates future concerns.

The closest comparison is with governments. The most effective governments are those that concentrate on doing only a few things, and doing them well. The worst are those that want to own and do everything.

Now, though, it is not just individual organisations that have become complex, but the interrelationships between those organisations that are Byzantine.

Legislation that attempts to define these interrelationships has proven woefully inadequate and, given the complexity, unlikely to ever offer a solution.

At this stage of the crisis, despite all the noise and political posturing, no one seems to have any idea of how to ensure greater risk transparency and allow bad news to travel rapidly so that future contagions can be weeded before they become critical.