Monday, October 26, 2009

On the Road to Fascism

Capitalism is recognized as the most robust economic plan known to mankind. The concept of “supply and demand” tied to consumerism, has shown the greatest opportunity for economic growth the world has ever seen. But like all things, it's greatest strength is also it's greatest weakness. The driving force behind free market capitalism is supply and demand, but what keeps it healthy is competition. Competition creates innovation, keeps costs in check and greases the skids of capitalism. Unfortunately the history of capitalism is fraught with those who would continually manipulate the free market by trying to eliminate competition. John D Rockefeller is famous for saying, "Competition is a sin". Eliminate competition and you inhibit innovation, but you vastly increase profits. The counter to this are anti-trust laws, but they have often proven to be too little and too late. By the time the anti-trust laws have kicked in, the damage has usually been done.

The other weakness is a complete lack of accountability in the financial markets. As mentioned before, the stock market was meant to be a place were companies could fund themselves by selling a proportion of themselves and their profits. The weakness here is what is referred to as a bubble. A bubble is formed when there is too big a gap between what a stock is worth and the amount a company had previously sold it's stock; this is refereed to as the primary and secondary market. This occurred in the 90s with dot com or NASDAQ bubble. Here the perceived value of start-up Internet companies was so high, that when a correction occurred (the secondary market fell and the bubble burst), most investors lost most or all the money they invested.

Additionally, there is the futures market, which was designed as an insurance policy. If the truth be known, farmers rarely know what the value of their crops or livestock will be when they finally come to market. The idea of futures, was for the farmer to find a buyer for their product at a reasonable profit. Say you buy corn or pork bellies, at an agreed upon price; this is the price the farmer will sell their product. If by the time the corn or pork bellies are sold, and the value is greater than the agreed to price, then you make a profit; if it is lower you loose money, but more important the farmers always have enough money to stay in business.

Mix Investment Banking and Futures and you have derivatives. A derivative is a formula to determine the value of a stock or better what is referred to as a Financial Instrument. The most common derivative is an interest swap. An interest swap occurs when you, Startup Company “A” needs a loan to expand. Currently the interest rate is 5%. Since you are a Startup company, the bank will not give you a long term loan and you know if the interest rate rises over 10% you will not be able to make the payments. Enter Corp B. Corporation B has been around a long time and it looking to invest some profits. Here an investment bank will set up a swap guaranteeing Startup A a year long 8% loan. Startup A will negotiated it's 5% short term loan, and as long as the loan percentage is at 8% or less, Startup A will pay Corp B, the difference between 8% and the current interest. If the interest rate goes above 8% then Corp B will have to pay Startup A the difference. While this kind of derivative can be beneficial to both sides.

Unfortunately these unregulated derivatives can have drastic consequences for the country if they are abused; I am referring to what was known as the sub-prime mortgage meltdown. The idea was all someone had to do was buy or “get into a home”, and the increasing value would allow the owner, regardless of their current ability to pay, an investment that they could re-finance until they could afford the house. Congress pressured the banks to make these home loans and agreed to buy most of the mortgages, so the banks would continue to have money to make more loans. The government then sold these mortgages to Investment Bankers and they in turn created Mortgage Backed Derivatives as high yield investments. Unfortunately, the derivative formulas would not work if the housing market dipped or started to lose money. Once that happened, Mortgage Backed Derivatives could not be valued, the Investment banks could no longer buy mortgages from Fannie and Freddie and the Banks ran out of money; that popping sound was another bubble bursting.

The problem was no accountability. The driving force that started this economic catastrophe was congress and the American Dream Commitment Act. Even though there were many warnings and attempts to rein in the problem, neither the Republicans or the Democrats wanted to turn off the money spigot and tell poor people they could not buy a house. To make matters worse, the Investment Banks sold unregulated Insurances policies on the Mortgage Backed Derivatives, called Credit Default Swaps (yes they are also a form of derivative). Because the Mortgage Backed Derivatives lost value, Credit Default Swaps kicked in and most of largest Investment Banks would have gone bankrupt (and some did) had congress not bailed them out with hundreds of billions of dollars. Interestingly enough, the regulations and accountability to stop this from happening (The Glass Stegal Act) had been in place for over 90 years. Glass Stegal was repealed in 1999 and it took congress and Wall Street only 10 years to repeat most the mistakes that led up to the panic of 1907 and the crash of 1929. Now this is not to say these same mistakes absolutely would not have occurred under fascism. A fascist dictator would most likely encourage inward economic growth tied to home ownership. However, fascism has also showed itself to be highly suspicious of banking and there would be no allowance in fascism for individuals to profit more than the state. The amount of paranoia and accountability, along with a lack of a free market, would have made the sub-prime meltdown almost impossible in a fascist state. Further fascism would almost eliminate the secondary market, as it is not easily controlled, which would put an end to the investment bubbles that have been like a wrecking ball to your average investor.

Of course, all this assumes that the fascist leaders have the state's best interest at heart. As mentioned earlier fascism usually rears it's head during economic down times. However, there is very little evidence that fascism can sustained. Fascism relies much on nationalism. Alexander Tyler wrote that democracy goes through 8 stages;

From bondage to spiritual faith;
From spiritual faith to great courage;
From courage to liberty;
From liberty to abundance;
From abundance to complacency;
From complacency to apathy;
From apathy to dependence;
From dependence back into bondage.

If this is to be believed, fascism usually intervenes in the “bondage to spiritual faith” stage and sticks around through the turbulent “spiritual faith to great courage” nationalistic stage. However once liberty raises it's head, fascism begins to loose it allure; power corrupts and absolute power corrupts absolutely. Those who are in power are not likely to relinquish their power, just because the people now want more freedom. Usually what you will see are manufactured crisis. As White House Chief of Staff Rahm Emanuel, "You never want a serious crisis to go to waste." Manufactured crisis are designed to keep the citizenry off balance and in need of the government to protect them. Emanuel continued his crisis statement with, "what I mean by that is an opportunity to do things that you didn't think you could do before". Lets hope that one of these "things", do not have the unintended consequence of fascism.

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