How Capitalism Will Save Us Read online

  The impact of these enormous corporations on the housing market cannot be overstated. Fannie and Freddie were responsible for some $1.6 trillion worth of less-than-prime mortgages by 2008 from banks and mortgage brokers, packaging them as securities and selling them to investors.

  With money flooding the market, some lenders didn’t bother documenting whether borrowers had any real income. These were dubbed “no doc” loans. Anyone breathing seemed to be able to obtain a mortgage. Sometimes no down payment was required.

  Contrary to the impression conveyed by politicians like Congressman Barney Frank and Senator Christopher Dodd, most lenders were more careless than predatory, making loans with free-flowing capital in a market that seemed certain to keep going up.

  The end result was a classic bubble of gargantuan dimensions. Then the Fed started to raise interest rates between 2005 and 2006. Everyone had previously assumed that subprime home buyers could always get a new mortgage with a new teaser rate when the teaser of an existing mortgage expired. But now those ultralow teaser rates would have to go up. Even if a home buyer got a new teaser rate, it was going to be higher than the old one. The market for home mortgages began to cool.

  The whole thing crashed in the summer of 2007. Subprime borrowers—particularly speculators or “flippers”—faced increased monthly payments and could not refinance or sell. They were stuck.

  Ironically, some of the same people who today criticize subprime lenders condemned banks in the 1970s for not lending to low-income communities. Back then, the practice was demonized as “redlining.” The outcry resulted in the 1977 Community Reinvestment Act, which required banks to offer credit to their entire market area and not just wealthier neighborhoods. Until recently, anti-redlining sentiment persisted. It has been credited by many with helping to create an atmosphere that only further encouraged subprime lenders. Moreover, the Department of Housing and Urban Development urged lenders to provide loans requiring no down payment for low-income people right up to the bust.

  Had the government not artificially lowered interest rates and done so much to encourage subprime lending, we would not have seen the recklessness that so distorted markets and led to the subprime meltdown. In a truly “free” market, fewer people might have gotten mortgages. But also fewer would have defaulted.

  People in the subprime crisis suffered not because of the immorality of free markets, but because of markets that weren’t free enough.

  REAL WORLD LESSON

  Government actions intended to help people often set the stage for even greater hardship down the road.

  Q IF CAPITALISM’S FOREMOST HISTORIC CONTRIBUTION HAS BEEN ITS MORAL INFLUENCE, THEN WHY DOES CAPITALISM APPEAR TO ENCOURAGE WHITE-COLLAR CRIME?

  A IN FACT STATERUN ECONOMIES ENCOURAGE MORE CORRUPTION THAN DOES CAPITALISM.

  At the height of the corporate-governance scandals several years ago involving Enron, WorldCom, and other companies, Time magazine asked: “Why a sleaze wave now? To some extent, it represents the dark side of President Reagan’s emphasis on the free market and individual enterprise.”13 William Greider, a writer for The Nation and a harsh critic of free markets, called the scandals “a teaching opportunity” reflecting the essentially corrupt and narrow “soul of capitalism.”

  Such views were not just voiced by the left. Then Federal Reserve chairman Alan Greenspan attributed the scandals to “infectious greed.” Time also quoted James Gattuso, policy analyst for the conservative Heritage Foundation, who observed, “We have more capitalism now, and it isn’t always pretty.”14

  These statements suggest that there would be fewer instances of white-collar crime and corruption if only we had more state control and less open markets. According to this line of thinking, without the temptation provided by the riches of capitalism, there would be less corruption and wrongdoing.

  Really? Real World experience suggests the opposite: free markets encourage less corruption. Government control—instead of reducing wrongdoing—produces more.

  There are relatively few measurements of white-collar crime. However, one international study by Transparency International, a nonprofit organization dedicated to fighting corruption, found that the United States is one of the least corrupt countries in the world when it comes to the crime of bribery. According to the report, about 10 percent of U.S. respondents reported paying bribes—unlike countries like Indonesia, Russia, Venezuela, Greece, and other nations, where as many as 50 percent of respondents reported doing so.

  Bribery is a daily fact of life in many of these nations. Annelise Anderson, a former government economist now at Stanford University’s Hoover Institution, says a key reason for this is overbearing state bureaucracies. In order to get anything done, people have to pay officials or find other ways to subvert an unreasonable system. Anderson writes:

  In general, excessive bureaucratic power and discretion provide the basis for corruption—for bribery, shakedowns, and extortion—especially when the criteria for bureaucratic decisions are unclear and difficult to monitor and evaluate. The corruption of a bureaucratic agency may begin with the clients of the agency, such as the members of a regulated industry. Thus building contractors may seek to speed up the work of the agencies that give building permits. More often, however, the bureaucrats originate the corruption by demanding payment. Getting a government contract may require a kickback; tips or bribes may be necessary to secure a wide variety of government services. In the Soviet Union bribes were necessary to secure everything from drivers’ licenses to medical care and even higher education, as well as goods.

  Cuba, with its controlled prices and black markets, illustrates just what Anderson is talking about. The St. Petersburg Times reported that

  the difficulty of making ends meet has turned ordinary Cubans into petty criminals…. Stealing from state workplaces or operating small, illegal businesses is so common that Cubans dismiss it as an almost acceptable part of daily life.15

  Ironically, one measure being considered in Cuba to remedy the situation is an expansion of private enterprise. Philip Peters of the Lexington Institute observed, “These are bitter facts to air in a place where socialist state enterprises are said to represent the revolution’s values, delivering services at fair, controlled prices without the exploitation or inefficiency of capitalist systems.”16

  One reason many people think prosperity brings more white-collar crime is that the definition of what constitutes white-collar crime changes with the political climate. In fact, some believe the government has gone too far in criminalizing economic behavior—making what are really regulatory violations into criminal offenses. Writes Paul Rosenzweig of the Heritage Foundation,

  Where once, to be a criminal, an individual had to do an act (or attempt to do an act) with willful intent to violate the law or with knowledge of the wrongful nature of his conduct, today it is possible to be found criminally liable and imprisoned for a substantial term of years for the failure to do an act required by law, without any actual knowledge of the law’s obligations and with no wrongful intent whatsoever.17

  Prosecutors are increasingly launching criminal prosecutions of individuals who do not meet the traditional test of “mens rea,” or criminal intent. For example, in the middle of this decade nineteen employees of the accounting firm KPMG were accused of issuing “abusive” tax shelters. In the past, this would have been pursued as a regulatory matter. Instead it wound up in criminal court. But prosecutors couldn’t prove their case, and a federal judge threw it out.

  Still, wouldn’t there be fewer corporate scandals, fewer Enrons and WorldComs, with less capitalism and more state control over markets? More control, of course, means bigger government. And government is even less transparent than the private sector—and has a more dismal record of safeguarding people’s money.

  According to the World Bank, some $1 trillion worldwide are paid each year in bribes to government officials. In Africa alone, more than $400 billion has been looted by government
officials and stashed in foreign countries.

  In the United States, taxpayer money is regularly pilfered for questionable and often selfserving purposes through the practice of congressional “earmarks,” allocations for frivolous spending that are slipped into appropriations bills with no hearings, examination, or oversight. We don’t usually think of earmarks as white-collar crime—indeed, many people would take exception to the idea. Yet some of the worst earmarks are indeed criminal, a result of bribes paid to legislators.

  FOX News reported on Pennsylvania congressman Paul Kanjorski, who earmarked $10 million in taxpayer dollars that ended up in a family-run company, Cornerstone Technologies, that eventually went bankrupt. Kanjorski’s story shows the double standard that can exist when determining what constitutes white-collar crime. Had the congressman’s misdeeds taken place in a public company, they would have been labeled theft.

  Yet few news organizations covered Kanjorski the way they did corporate crooks like Enron’s Andrew Fastow and Jeffrey Skilling. Fastow and Skilling went to jail. Kanjorski is still in office.

  REAL WORLD LESSON

  There will be dishonesty under any system. However, capitalism’s dependence on winning the trust of consumers, as well as the rule of law, discourages corruption and encourages the most transparency.

  Q IF CAPITALISM IS MORAL, THEN WHY DID FREEMARKET REFORMS APPEAR TO INCREASE CRIME AND CORRUPTION IN POST-COMMUNIST RUSSIA?

  A BECAUSE RUSSIA IS NOT YET A DEMOCRATIC FREEMARKET ECONOMY.

  Freemarket critics love to hold up the crime and corruption of post-communist Russia as emblematic of the fundamental immorality of unbridled capitalism. Yet Russia’s economy is hardly a democratic free market.

  In 2009 the Heritage Foundation, the noted freemarket think tank, gave Russia’s economy a 50.8 percent rating, calling it “mostly unfree.”18

  Putin’s authoritarian “managed democracy” is more intrusive in the economic lives of its citizens than that of his predecessor, Boris Yeltsin. True, things have improved since the lawless 1990s. The Russian economy is growing. There are privately owned businesses and an increasingly affluent middle class. The tax code has been drastically simplified. Steps have been made toward the creation of Western-style property rights. But there is still not the kind of rule of law and property-rights protections that we take for granted in the United States. Nor does Russia’s court system effectively mediate disputes.

  Russian economist and political leader Grigory Yavlinsky has noted:

  “We do not have independent courts in Russia. … The law enforcement

  system is corrupt and has been transformed into an instrument of revenge and the grabbing of property.”19

  It is still not easy to launch a new business in that country. According to the Heritage Foundation, getting a new business license still involves plenty of red tape, taking “much more than the world average of 18 procedures and 225 days.”20

  Small wonder that Yavlinsky, while acknowledging reforms, has derided his nation’s system as “phony capitalism”: success or failure in the Russian marketplace depends on political favors, i.e., paying bribes and protection to officials or their cronies. The contrast with Western-style democratic capitalism, he says, is “stark.”

  We discuss later in this chapter that Russia’s oil wealth has helped to create this appearance of affluence—the “phony capitalism” described by Yavlinsky. Russia’s corruption is the product not of free markets, but of an authoritarian government that hasn’t permitted them to flourish.

  REAL WORLD LESSON

  Government-dominated “phony capitalism” suffers from the same corruption as other state-controlled societies.

  Q WHY HAVE RUSSIA, CHINA, AND OTHER NATIONS FAILED TO DEMOCRATIZE FOLLOWING RECENT FREEMARKET REFORMS IF CAPITALISM PROMOTES MORE OPEN SOCIETIES?

  A DEMOCRATIZATION OCCURS FASTER IN SOME COUNTRIES THAN OTHERS.

  Freedom House, the nonpartisan organization that monitors political rights around the world, in 2008 announced a disturbing finding: for the first time in years, there had been a “setback in global freedom” in one-fifth of the world’s countries. Yet many of the backsliding nations, such as the former Soviet Union, had instituted freemarket reforms. Other countries, like China, continue to have “closed” political systems despite economic liberalization. According to the organization, this decline continued as of 2009.21

  These and other developments have been held up as evidence that free markets don’t bring free societies after all. The New York Times declared that “both liberal and conservative intellectuals, even once ardent supporters, have backed away” from a belief in capitalism as a democratizer.

  Then there are those like Yale law professor Amy Chua who maintain capitalism actually hurts poor nations. She wrote a book with the incendiary title World on Fire: How Exporting Free Market Democracy Breeds Ethnic Hatred and Global Instability.

  Chua claims that instead of planting the seeds of democracy in struggling countries, capitalism in fact makes things worse, exacerbating ethnic conflicts and widening the gap between rich and poor. She points to nations like Nigeria, that, despite having open markets, continue to experience bloody tribal conflicts and have failed to establish democracy.

  Chua’s perspective is no doubt partly shaped by personal tragedy: her well-to-do aunt, a Chinese businesswoman living in the Philippines, was stabbed to death by her chauffeur. For some people, her arguments may appear compelling. Yet they reflect a poor understanding of the history of democracy and an ignorance of Real World economics.

  No, capitalism does not magically turn nations into American-style republics overnight. But political scientists have documented the relationship between free markets and free societies.

  Cato Institute analyst Daniel Griswold has found that “the most economically open countries are three times more likely to enjoy full political and civil freedoms as those that are economically closed. Those that are closed are nine times more likely to completely suppress civil and political freedoms as those that are open.”22

  Griswold cites research showing that since the nations of the world began to liberalize their economies in the mid-1980s, the percentage of democratically elected governments surged from 40 percent to over 60 percent today.23

  When you think about it, the link between economic and political liberty makes sense. Free markets not only demand, but teach, the skills needed for political self-governance. Griswold explains, “Economic freedom and trade provide a counterweight to governmental power.”24 That is because under capitalism you, and not government, are responsible for most day-to-day economic decisions, from how to raise money to start a business to how to take care of the maintenance of your home.

  Sooner or later, people realize that if they can vote with their money and choose their refrigerator or automobile, why shouldn’t they have the similar ability to vote at the ballot box and elect their officials?

  Truly free markets also require an open flow of information. A Silicon Valley can emerge only when people have the freedom to develop and exchange ideas. Capitalism also fosters democracy by encouraging the growth of a better-educated middle class—people who are more likely to make demands of public officials.

  As for Russia and China, it’s true that they remain politically repressive. But both nations allow more personal freedoms than they did under communism. In China, the days of murderous Maoist campaigns like the Cultural Revolution and the Great Leap Forward, which took the lives of tens of millions, are over. People now have property rights to their apartments and the ability to travel. Tens of thousands of entrepreneurs have created new businesses.

  The New York Times reported that China’s growing middle class is increasingly pushing back against authoritarian rule: “The new property owners have poured their energy into everything from establishing co-op boards to spar with landlords, to organizing real estate market boycotts to force down prices. Others, meanwhile, have begun running for office in district-l
evel elections, where they hope to make the city government more responsive to their needs.”25

  The Times quoted a scholar at the China Development Institute who observed “an awakening of awareness on public issues” and civic leaders who see “a steady growth in citizen involvement.” This was clearly the case after the 2008 earthquake disaster in Sichuan Province, which led to an outcry against corruption, which was blamed for the shoddy “tofu construction”26 that helped cause some seventy thousand deaths and countless other casualties.

  In Russia, observers are justifiably alarmed by the crackdowns that have rolled back the democratic reforms that followed the collapse of Soviet communism in the 1990s. Even so, most Russians today have more personal liberties than they ever had in their blood-soaked history. A political demonstration will get you arrested and your head cracked. But you don’t have countless thousands of people being arbitrarily rounded up and sent to the Gulag, as they were under the old Soviet authoritarianism.

  The reason Russia hasn’t democratized is because it is still a statedominated economy. Most of the country’s vast wealth comes not from free markets but from revenue produced by its oil and other natural resources. Experts have called this “the Oil Curse.” This resource-driven prosperity creates the illusion of capitalism while preserving the power of oligarchs and an authoritarian government. Like welfare or big inheritances for adolescents, the oil curse removes the incentive for governments to encourage a diversified, entrepreneurial economy.

  Russia isn’t the only authoritarian society propped up by its natural resources. Since the new oil boom that started in 2004, huge windfalls have bolstered the economies of not only Russia, but also countries like Iran and Venezuela. These are the countries that are the backsliders—or outright failures—on the freedom index. Their resource-rich “phony capitalism” provides a smoke screen for anti-capitalist, big-government policies.

  Take a country cited by Amy Chua—Nigeria. Sure enough, it, too, is beset by the oil curse: it produces 10 percent of the oil consumed by the United States. That’s lots of petrodollars flooding its coffers. Not surprisingly, the Heritage Foundation/Wall Street Journal Index of Economic Freedom rates the country as “mostly unfree.” It lags behind in freemarket essentials, such as property rights, contract enforcement, ease of setting up legal businesses, and sensible taxation. Therefore, Nigeria can hardly be called a free market, and thus it is no surprise the country continues to experience political turmoil.