Capitalism at bay
economist.com
economist.com
I'm back.
[T]he market place [is] revaluing assets inline with their true values.
This begs the question of how the assets became overvalued in the first place. The answer, though hard for market apologists to swallow, is that the market did it. We can't simply presume that every good thing that happens is due to the market and every bad thing is some unexplained phenomenon.
[T]hat is not the fault of capitalism but the fault of people playing silly buggers.
This is the No True Scotsman fallacy. We can't say that "True Capitalism" would have fixed this, but people playing silly buggers are the cause of all the trouble. News flash: The market is composed of people playing silly buggers! This is the very crux of the point. "True Capitalist Markets" may always value assets best when unregulated, but "True Capitalist Markets" don't exist. Classical free markets are a mathematical construct in which all the agents act rationally but with imperfect information. Real markets are real constructs where the agents are silly stupid human beings with all their irrational beliefs and psychological frailties. This is why there is an emerging field called "Behavioral Economics." This is why there was an article by Paul Krugman featured here the other day about why real markets failed English Cuisine for a century or more.
The point can be beautifully summed up in a joke I read once: An economist and his granddaughter were walking along when the granddaughter saw a $20 bill on the sidewalk. Anxious for moral guidance, she tugs on her grandfather's shirt and asks, "Should I pick up that $20 bill?"
"Nonsense," replied the economist. "If that were a real $20 bill someone would have picked it up already."
However, I think that we really are in disagreement. There was some government policy that was bad for the market (easy money leading to bad lending) but the creation of credit default swaps certainly has to fall under "the (real) market."
This is my point about the No True Scotsman fallacy. Buying a credit default swap certainly had to be a bad idea from the very beginning. You're insuring an asset that you don't (necessarily have to) own. This falls right under the classical definition of a "Moral Hazard." However, they were bought by the very agents (or at least agents indistinguishable by market theory from the actual agents) that compose the market that is now correcting itself. The agents were incapable of seeing the disaster ahead. This either means that they weren't rational (in which case we don't have a 'market') or that they were rational (in which case free markets really did get us into this mess). I don't know which is more frightening.
The analogy is often made that free markets allow a kind of evolution to occur. The fitness function is profitability/solvency, and the organisms are investors, organizations, consumers, et al. I think this is a great analogy, but it does have some interesting implications. Fraud happens in nature (caterpillars that mimic ant pheromones to invade ant nests). Boom/bust cycles happen in nature (algal blooms, even in the absence of agricultural runoff). Parasitism happens in nature. All of these things have market analogues. Indeed, all of those analogues figure highly in the current debacle.
While "[h]eavily socialist systems can shield people from the truth of a problem," they can also shield people from the worst of market excesses. There doesn't seem, to me at least, to be any kind of fundamental reason why regulation and government action, socialist or otherwise, either has to shield people from truth or is incapable of shielding people from what could turn out to be very dire consequences.
Free markets won't [languish indefinitely]
The Krugman article I mentioned (http://web.mit.edu/krugman/www/mushy.html) actually talks about a case in which a free market will languish indefinitely, namely, if nobody knows to expect any better than they're currently getting. This is just one of the many consequences of the fact that the agents that compose real markets differ significantly from the rational agents of classical economics. I mean, presumably, people who advocate for free markets aren't heartless and bloodthirsty. They advocate, fundamentally, because they want what's best for everybody. I think it's important for them, in light of their desire to do good, to take an honest look at the limitations of the theory and ask, "Are we going to get what's best for everybody by blindly implementing classical economic theory with disregard for the differences between the model and reality? Or are we going to do better by implementing it only so far as it goes and then putting other systems in place to ameliorate the worst of its excesses in the fairest manner we can find?" This is fundamentally a philosophical question, not an economic one.
Regarding what you actually said, I'll have to do some more investigating/thinking. I will concede you seem more knowledgeable than myself on this matter however the INTP in me won't concede defeat until my spidey senses stop tingling! I'll let you know if it does.
(I do like the evolutionary analogy. I think they're extremely apt).
I found an interesting connection made between the internet bubble and the housing bubble caused by interference from the Fed (the source has a capitalist bias):
"Injections of liquidity to stop the meltdown in the wake of the failure of Long Term Capital Management fueled the internet bubble. Injections of liquidity to avoid a market crash when the internet bubble burst fueled the housing bubble. Now, following the bursting of that bubble, the Fed is making historically huge amounts of credit available to keep the economy afloat." http://www.atlassociety.org/cth-43-2085-credit_crisis.aspx
Another piece of the puzzle.