English: Wall Street sign on Wall Street (Photo credit: Wikipedia)
The abuse of unregulated derivatives by Wall Street caused the Great Recession. That is the conclusion reached in Republic, Lost, How Money Corrupts Congress–and a Plan to Stop It by Lawrence Lessig. The following quotation is the simple analogy he uses to explain what happened. The regulation of derivatives is compared to laws regulating automobile highway speeds.
“A speed limit that applies to black cars only will not only incentivize the sale of colorful vehicles, it will also be a boon to the paint departments of auto body shops everywhere. That’s the story of Wall Street in the 2000s. While some portion of the market for derivatives was no doubt driven by a genuine meed for the particular flexibility of a derivative, a huge proportion was simply black cars being painted red. The winners in this new market were the drivers of those freshly painted cars, and the firms that had done the paint jobs (aka Wall Street). The losers were–surprise, surprise–the rest of us.”
The derivatives in question were backed by US mortgages and rated AAA by Standard and Poor and others. Derivatives were exempt from regulation by act of Congress as urged by Alan Greenspan and others. Financial instruments still regulated by law were recast as derivatives to escape regulation. And without the discipline of regulation, Wall Street took on excessive risk. And it came tumbling down in 2007-8 birthing the Great Recession.
Profile of Adam Smith (Photo credit: Wikipedia)
Free market capitalism, laissez-faire capitalism, Adam Smith’s invisible hand acting to create the greatest good for the most people does not currently exist. Without effective government regulation, competitors tend to merge to reduce competition, letting them raise prices, reduce supply and make more profit. For example, just look at the oil companies and gasoline prices at the pump. What we have now instead of free market capitalism is what I call pickpocket capitalism. Adam Smith’s invisible hand of the market is in all our pockets, stealing cash from incomes unnoticed, and almost invisibly. Sky high interest rates on credit cards and insurance policies that don’t cover the insured costs are two more examples of the invisible hand of the pickpockets of corporate America. Only effective regulation by the Federal government can protect us from them. The states are too small and diverse to do the job. The ultimate solution of course is to breakup the companies that are too big to fail until they are small enough to start competing with each other once again.
Truthout.org has an interesting companion article.
Image via Wikipedia
I received a petition request for signature this morning from John McCain. It was a stark reminder of his claim in 2008 not to have a strong understanding of the economy, and it reinforced why he lost. He supports the GOP plan to grow the economy to provide jobs in the long term by reducing taxes and government regulation. We need jobs now, and only government is capable of stimulating the economy now. John McCain can shuttle from one home to another while ordinary Americans suffer. While he is doing that, perhaps he can count the homes he owns so that next time he runs for office he will know the number.
Please see Let them eat cake | 999 tax plan | Great Depression 2 | If John McCain had won