Will the Government Destroy American Capitalism?

You're living through a financial meltdown unlike any other in American history. The destructive forces now being unleashed are so potent and powerful that they threaten not only to trigger a severe recession, but also to attack the core underpinnings of capitalism itself. If left unchecked, the long-term consequences will be disastrous.

I'm speaking, of course, of the U.S. government and its heavy-handed interventions. The law of unintended consequences is still stronger than any bailout package or regulation, and the more strongly the government intervenes, the bigger the problems it causes.

Capitalism's underpinnings
Two things are absolutely key to any market economy's success: contract integrity and consequences for failing to deliver. Through its attempts to "help," the government has essentially nullified both. While its actions may seem politically expedient in this contentious election year, the long-run results will be devastating.

For example, shortly after taking over failing bank IndyMac, the government halted foreclosures on that bank's defaulted loans. While that may sound like a kind thing to do for distressed homeowners who found themselves in over their heads, the message it sent was anything but kind to the rest of the market.

To other lenders, the message was, "Don't make a mortgage loan with the expectation that you can foreclose if the borrowers miss their payments." To prospective borrowers, the message was, "Go ahead and continue to take out mortgages you don't understand, on houses you can't afford. We'll protect you from the consequences if you screw up."

In an environment like that, where the contracts aren't respected and failure isn't punished, is there any wonder why banks are treating nearly every mortgage applicant like a likely deadbeat? Any Fool should have seen that coming.

Freddie, Fannie, and AIG.gov
As misguided as the decision may have been to halt IndyMac's foreclosures, at least the government had some legitimate basis for its takeover of that failing bank. Not so with its other major interventions, like the feds' guarantee of billions of Bear Stearns' liabilities to sweeten the pot for JPMorgan Chase's (NYSE: JPM  ) takeover of that failing broker.

Emboldened by that bit of economic engineering, and an apparently financially illiterate Congress exercising questionable oversight, the feds have continued to maul the markets. Thanks in part to yet another bailout, the U.S. Treasury completely controls Fannie Mae (NYSE: FNM  ) and Freddie Mac (NYSE: FRE  ) . Almost ironically -- and ominously, when it comes to the potential for fixing things in the future -- the seeds for their destructions were largely sown by their so-called saviors.

Now our government is the proud owner of failing insurance giant AIG (NYSE: AIG  ) . Like Bear, Freddie, and Fannie, AIG overleveraged itself to make gigantic bets on mortgages and derivatives based on the housing market. Like the other aforementioned beneficiaries of the government's largesse, AIG and its principals benefited from those bets when they were winning. Of course, now that they've gone bad, you and I, the American taxpayers, are stuck with the costs of cleaning up their mess.

Bad mortgages? Toxic derivatives? Excessive debt? All wholly owned subsidiaries of, or backed by, the U.S. government. No wonder gold just had its largest one-day price jump in history, the dollar has once again started sinking, and oil has bounced back from the dead. The feds seem to be doing everything in (and beyond) their power to destroy the very foundation of the country's success, all to bail out billionaires.

The right model for failure
Troubled companies with legitimate assets can often find a home without endangering the public's finances -- even if they're large financial businesses. Bank of America (NYSE: BAC  ) , for instance, bought out troubled lender Countrywide, and it's in the process of acquiring prime broker Merrill Lynch (NYSE: MER  ) after the latter stumbled. No bailout needed.

Even Lehman Brothers is settling its failure the market-friendly way, under bankruptcy protection, and for the benefit of senior debt holders, under an impartial judge. Sure, vulture capitalists like Barclays (NYSE: BCS  ) stand to benefit by picking apart Lehman's carrion, but at least we taxpayers aren't saddled with the risks.

If capitalism is going to survive this crisis, it needs more Merrill Lynch-, Countrywide-, and Lehman Brothers-style failures, and fewer government-subsidized ones. Let the market participants bear the full risk and cost of failure. It's the only way to ensure that the lessons learned from this debacle will help dampen, rather than exacerbate, the next round of problems.

Otherwise, the long-term consequences to American capitalism itself could be absolutely apocalyptic.

At the time of publication, Fool contributor Chuck Saletta owned shares of Bank of America. JPMorgan Chase and Bank of America are Motley Fool Income Investor recommendations. The Fool's disclosure policy is exercising its option to get paid in British pounds.


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  • Report this Comment On September 19, 2008, at 3:28 PM, AndyHeil wrote:

    Finally, someone making sense. This entire bailout is absolutely ridiculous. Free market systems only exist in bull markets apparently - when everyone can make money - regardless of how irresponsibly they do it. Banning short selling is a joke. Bailing out billonaires, as Chuck puts it, is even worse. Keep in mind, these are some of America's most privileged and well-educated financial minds creating this mess with their irresponsible financial decisions. Chuck's coment that home buyers can "go ahead and continue to take out mortgages they don't understand, on houses they can't afford while the governement protects themf rom the consequences if they screw up" aptly applies to Investment banks, gov't sponsored entities, and behemoth insurance companies. The message is also make as much money as you can, however you can, and if stuff goes bad, then who cares - the gov will step in sooner than later. The other message is - the bigger you get, the better off you are because you essentially ensure yourself against failure. Again, the gov will bail you out. You just can't save and eliminate bad choices like this. Eventually things will catch up.

  • Report this Comment On September 19, 2008, at 3:44 PM, nooliver wrote:

    What's behind all this?

    GREED, GREED AND MORE GREED.

  • Report this Comment On September 19, 2008, at 5:04 PM, Ragbaby wrote:

    Thanks for a very honest assessment of what's going on now! The question for me is: How do we stop our government from doing the foolish expedient thing and get it to look at the long term in decisions for our country's health and the citizens in it?

    This kind of action from our government just makes me angry ALL the time.

  • Report this Comment On September 19, 2008, at 5:25 PM, foolabomb wrote:

    Chuck, it's like you were reading my mind. I was just talking about the same thing the other day (although you said it much better).

    To Ragbaby - we live in a representative republic. That means the people we elect are supposed to represent our interests. I know there are plenty of people appointed to positions, but they are appointed by people we elect. We need to remember who voted for these types of actions. We need to let those representatives know we think their actions were wrong, and not in our best interest. We need to let them know that unless they can figure out how to undo what has been done (or at least stop doing it in the future), they will no longer have our votes to represent us. Then we need to vote for the people who will do what we want them to do. It's not easy, and it doesn't always work. But it's the way our system was built. The onus is on the American voter to go make a difference and to pay attention to what these representatives actually think and what they say they are going to do, not what they look like or their experience.

    Might as well just centralize the economy and be done with it. Clearly that has worked for the Soviets and the Chinese. Oh, wait.....

  • Report this Comment On September 19, 2008, at 8:35 PM, 8Buckeye wrote:

    I find it strange that you're blaming the government for trying to destroy capitalism. It is the unfettered action of very GREEDY capitalist that have caused the government to react. If they hadn't stepped in we might be seeing one of the biggest meltdowns in the history of the world financial system but since we won't you can sit back now and say what they did was wrong when even any understanding about the financial system would tell you otherwise.

    I have to ask if you're the same person that will gripe about regulations that would have kept something like this from happening. What brought this about was the same type of free market thinking that you are expousing. Unless of course that you think that giving out loans that people cannot afford, creating investment vehicles with these loans and selling them , creating insurance that would supposedly protect these without any real capital in place that would have even covered 1/25 of their value, whichin the end when the birds cam e home to roost looks an awful lot like a PONZI scheme at the highest level. Of course as long as it is FREE maket cpitalism that made it OK.

    The government had very little choice but to step in and do something. Probably 9 out of 10 people with some knowledge of the financial system while they might not like it would at least aknowledge what it would have happened if the government had not reacted. It is akways easy to blame the government , they are everybodies whipping boy. Many folks need to look in the mirror and what they will see is that they ARE the government, this is their system and their own actions and attitude let this happem and mainly in the name of free maket capitalism run amok.

    GREED for a better word is not always good!!!!!

  • Report this Comment On September 19, 2008, at 9:01 PM, mattandorson wrote:

    The continued bailout removes the consequences of failure. Chuck is right on the mark. Weakening accountability is weakening market principles needed to price risk correctly.

    This lack of accountability extends to the lack of transparancy in operations of the fallen financial institutions. Nearly all publically traded companies still fight shareholder input on executive compensation. Again, risk not linked to reward; bloated CEO compensation is paid even as financial failure looms.

    We need stronger government involvement in forcing honest financial statements and stronger shareholder influenece; we do not need our taxes used to smooth over/stretch out the poor decisions of a greedy elite.

  • Report this Comment On September 19, 2008, at 9:14 PM, PubLib wrote:

    Um... Non-intervention and deregulation are exactly what caused the mess we find ourselves in at the moment. Although at this point I do think that we should have just allowed the entire system run amok and totally collapse upon itself leaving nothing behind (except perhaps a few drooling brokers)... It might be the only way to truly save us. Darwin is so right.

  • Report this Comment On September 19, 2008, at 11:19 PM, 4manicow wrote:

    I recently read "An Empire of Wealth" by Gordon. Great read. Covering 400 years of American economic history since the Virginia colony, with and without a central bank, on or off the gold standard, we have had booms and busts.

    The US dollar has been worthless twicve before. Letting the free market make the necessary changes has always allowed us to grow back stronger. The current attempt to massage the truth will lead to a greater and more prolonged collapse. Most importantly, END THE FED!

  • Report this Comment On September 19, 2008, at 11:53 PM, doctordave77 wrote:

    I agree with 8Buckeye. There was little choice but for the government to step into this quagmire and sort it out. If they had not acted, and the result worked through the system, I believe we would have seen at least a 1920's-30's repeat. If AIG is allowed to fail, the ball starts to roll across the world, and who knows where and how it would have stopped. Market corrections like the ones we have started to see lately, aren't somewhat scientific like the justice system. They are exactly like the ball analogy, they roll over the innocent and the guilty.

  • Report this Comment On September 20, 2008, at 12:51 AM, GoNuke wrote:

    I think Chuck Saletta is missing the point of this crisis. I am a foreigner who invests in the US. I do so because it is a safe place to invest. I may lose my money because -despite the best efforts of management, the companies I invest in may fail; but I do not fear losing my money to thieves as I might if investing in an unregulated market.

    The US securities markets are free and fair because they are regulated. What happened recently was a consequence of dubious ethical practices on the part of people that should have been trustworthy -US law should ensure they are trustworthy. It did/does not. US society is doing the right thing by taking responsibility for the actions of its citizens and working to maintain the integrity of the USA "brand".

    US law tolerated lending of money to people who were unlikely to be able to repay. In essence some institutions were able to produce bogus financial assets which changed hands many times before being sold to customers as investment grade securities. This could be considered theft or fraud or counterfeiting even. Due diligence rules are in place to prevent this. My guess is that few fulfilled their obligations with respect to due diligence. The SEC is designed to prevent the stock market from becoming a den of thieves and it is the US reputation for transparency and fairness that attracts both domestic and foreign capital.

    Those of us who put our faith in the US system (including Americans) were wronged, robbed even, and it is only fair that US society/government take action to mitigate our suffering. Now the US is going to have to work hard to restore long-term confidence in its system.

    Make no mistake the US brand was severely tarnished. The evidence of this was the resistance on the part of individuals and institutions, domestic or foreign to lending money to US firms.

    This meltdown was not just a consequence of acts of a dubious ethical nature -which most certainly should be governed by law.

    It makes sense not to lend home buyers 100% of the purchase price of the house. Surely the Tokyo real estate crisis demonstrated the folly of giving everyone at the auction an unlimited supply of other peoples' money to bid with. Not limiting loans: to people who are sharing in the risk; or to borrowers with a demonstrated ability to repay removes all risk from the borrower. Selling the loan to another institution removes the risk from the primary lender.

    This is not free market capitalism.

    Free market capitalism has inherent constraints -money is neither lent nor borrowed without risk. In the US this constraint was dodged and should be restored by regulation.

  • Report this Comment On September 21, 2008, at 12:09 AM, lowfiron wrote:

    Ah! Right on Go Nuke.

    On top of that what are the consequences for us working class people? I hear Herbert Hoover again.

  • Report this Comment On September 21, 2008, at 9:01 PM, peysson wrote:

    I couldn't agree more! It's obscene that the government feels the need to bail out the fat cats who've lined their pockets over the last few years, contributing significiantly to the creation of this mess, and even now in the midst of their failure will add even more to their wealth even while being shown the front door and collecting on their parachutes. And now we, the taxpapers, are going to foot the bill?!?! I don't profess to understand completely what the consequences would be if the government didn't interfere, but I know enough to smell trouble when the system is prevented from running its natural course, whatever that may have been. Chuck's take on this is right on the money!

  • Report this Comment On September 21, 2008, at 10:58 PM, EBStroke wrote:

    I agree with 8Buckeye & Go Nuke.

    My personal hope and prayer is that Congress (both sides of the aisle), Treasury Sect Paulson, the FED, the SEC can all hammer out:

    1. a bipartisan short term rescue legislation now

    2. a long term durable regulatory regime that can improve financial transparency & eliminate the execsses of the past.

    I know that Congress will struggle to find the right language. There will be many who will resist the restructuring process; from both Wall Street (especially the hedge funds), academia, and from the existing regulators and lobbys.

    But this is the time for personal courage. Please do pray for the wisdom of our representatives.

  • Report this Comment On October 01, 2008, at 2:51 PM, NanoSponge wrote:

    To boil it down, we're expecting the taxpayers to give money to these institutions so that they can lend it back to the taxpayers, with interest. Incredibly, the taxpayers are expected to believe that this arrangement is intended to do them a favor. I shudder to consider that my fellow citizens might, in the aggregate, be that dense.

    Add any riders you'd like; a bail-out is a bad deal for taxpayers, and I for one will vote forever and always against any candidate who voted for or supported this grand swindle.

  • Report this Comment On October 08, 2008, at 12:43 AM, jet59 wrote:

    I finally found someone who has touched on some of the real facts about this AIG "thing". But of course, it is not a national crisis as was being sold to us by the politician, but now that the Bill is passed into law the real picture is being presented in a whole different way. Now it's the "global economic crisis" over and over on their tongues, as if it was never denied. They are trying to say the home- owner will be put back in charge when it is the government that will be given charge. The main stream media is shallow in explaining what is really going on. The dishonesty is immense and maddening.

    How in the world can people have bought into the "national crisis" bit? AIG is as the "I" stands for- an International Giant and this so called bail out (take over) should have been addressed on an international level and the US government never should have caved in to the pressures of the European Union. Or did the US gov. buy out the mortgages because they couldn't wait to get their greedy hands on it all?

    I think we have only been shown the tip of the ice-berg.

    Was Bush pressured by international forces to bail out AIG? The G7 is meeting soon. Looked like Congress played up a good act by resisting the bail out but I think they knew all along they had to do this thing and had every intention of passing it. Families all over the world are losing their asetts and the United States is bailing out the failing global economy. Unbelievable. The United Nations convened in NY the same day AIG asked for money. That was very coincidental. Other central banks and governments should have added to the kitty for this bail out but they didn't. How charitable.

    There is so much the average american like myself can't possibly know about this odyssey. So is it fair to ask any question or to make any accusation no matter how stupid they sound?

    BUYING BAD MORTGAGES?

    Is this a common practice? Or a new concept? I ask half facetiously but seriously. Then something about converting them into treasuries. WHAT PRODUCT IS THE GOVERNMENT BUYING, REALLY?

    HOUSES? Is the government purchasing bad mortgages from AIG and taking over foreclosures? Are they planning to sell all these houses back to the market?

    I am thinking that they own real property. It really isn't being explained clearly to the average American. And the average American doesn't want to look average so they aren't admitting that they don't know what is going on! But our instincts are telling us it's bad. Media members and politician say the government owns "bad PAPER/ bad mortgaes" . What does that mean? Are they going to go after these people who abandoned their homes or what?

    PAPER? Well, that's impressive. I want to hear from all the people who made these bad mortgages and explain this remarkable and confusing issue to us. Maybe they can do a better job at it. If any of you millions are out there please... or maybe you don't get it either.

    A global economy is wonderful until it collapses. There are no safe havens then. There are a lot of dirty secrets and most of them are about sowing seeds of destruction for the American economy and our freedom.

    In fact the plan is in place and accomplished it seems. Sadly all that's left to do is for the plan to be implemented or for socialism to move in.

    If the socialist Obams gets elected it will be a new era for socialism in this country. His victory is a major expectation for the plan and one of the main implements needed for it's success. It is absolutely no coincidence that he is the candidate for election because he was the man chosen to begin the new era. I think it might happen. It's all too obvious and when anything so sinister becomes this obvious than you know it is too late as well to stop it from happening.

    It is sinister for the government to take over or socialize the largest insurance co. in the world.

  • Report this Comment On November 03, 2008, at 3:06 PM, Michael75065 wrote:

    Greed and apethy is going to destroy America. $10 trillion dollar in debt and social security, medicaid and medicare are broke and nobody in America cares and we need to do something now and nobody wants to do whats takes to change and were spoiled. If wasn't for other countries bailing us out we be a mess.

    The new presidents not goung to be able to do a thing or what he promised were to much in debt and broke.

    Also global warming is going to destroy the earth if we don't change are way.

    Everything in the bible is coinmg true and it's a mess and man will destroy this world and it's sad.

    Maybe people have gave up or can't handle helping America to be the best.

    We need to change are ways badly. We lost are morals, values and intrgety in Ameica we need god back in life and do what gods wants us to do badly.

    I have degree in marketing and been in business all my life and scary what I see. Wish I could do something.

    If you like to email me:

    Michael75065@Yahoo.com

    Michael Ladd

  • Report this Comment On November 03, 2008, at 3:13 PM, Michael75065 wrote:

    We also need term limitation in congress and campainge finance

    or will never have a fair election.

    I don't even like to vote. Nothing going to change But I can only pray.

    Michael75065@Yahoo.com

    MJichael Ladd

  • Report this Comment On January 12, 2009, at 9:01 AM, BARBBF wrote:

    Social Security: The Phony Crisis

    Dean Baker and Mark Weisbrot

    http://www.press.uchicago.edu/Misc/Chicago/035468.html

    Mark Twain once said that a lie can get halfway around the world before the truth even gets its shoes on, and it’s hard to find a more compelling example than the lie about Social Security’s finances. Despite the fact that none of the numbers cited here are a matter of dispute, the public has been overwhelmingly convinced that Social Security is in deep trouble. According to a February 1998 poll by Peter Hart Research, 60 percent of non retired Americans expect Social Security to pay much lower benefits or no benefits at all when they retire. The proportion is even higher, at 72 percent, for people aged 18-34.

    Ironically, the only real threat to Social Security comes not from any fiscal or demographic constraints but from the political assaults on the program by would-be “reformers.” If not for these attacks, the probability that Social Security “will not be there” when anyone who is alive today retires would be about the same as the odds that the U.S. government will not be there. The latter event is, of course, a possibility, but not enough of a likelihood that most people would plan their retirement around it.

  • Report this Comment On March 18, 2009, at 7:34 PM, wickfordri wrote:

    Capitalism: "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."

    It might be said that the goal of an economic system is the production of goods and services which a population values and wants. If those products are priced fairly the consuming public will purchase them, the producers will make profits which can then be used to grow their businesses, hire more people and expand the economy, creating more wealth, and so on...

    So what just happened?

    Maybe we lost site of the goal: to produce products which have value for the consuming public. It seems the more ethically challenged of Wall Street and our financial markets have achieved the alchemist's dream; they found a way to create something out of nothing, which they then sold at a profit. And this is how they did it.

    They convinced gullible and/or naive buyers that the rising home prices will continue and that market values are no different than real money, just like money in a bank. These buyers then borrowed on that so called "market value", often more than they could afford to pay back, believing that if they got into financial trouble, they could always sell their homes at a higher price, and come away with a profit.

    (NB. The only time the market value is real is when a willing buyer buys from a willing seller. That agreed upon price is generally considered "market value".)

    The predators in the financial and banking industries then took these mortgages, bundled them together so that they were impossible to analyze and price fairly, then sold them as 'investments', taking their cut of course, thus creating wealth for themselves without actually producing anything of true value. They even have an important sounding name - Mortgage Backed Securities or MBS.

    The goal was no longer the production of quality products or services to produce a profit. The goal now was only to create capital, money. That nothing useful was produced in the process was of no importance. Gordon Gekko lives. For the cinematically challenged, Gordon Gecko, in the movie "Wall Street" pronounced "Greed is good!"

    And worse still, it was based on an illusion, a Ponzi scheme - the idea that the market value of anything is no different than real money, instead of what it actually is; a best guess, a hope, a gamble. We have built our financial markets on illusions, a gamble and we are now suffering the consequences of that pipe dream. We've been "Madoffed".

    I hope we can return to our original goals - making high quality things and providing high quality services that people want and can afford. The profits will follow.

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