International Policy Issue, Essay Example

The end of the cold war that occupied the second half of the last century has often been interpreted as the triumph of capitalism over communism. But some may argue that the real factors behind US eventual victory were its more brilliant execution of military and diplomatic strategies that internally weakened the USSR, eventually leading to its collapse. Whatever the real reasons maybe, it did help advance the ideas of free market proponents that perceive any government intervention as ineffective and unnecessary. Proponents of capitalist contend that the forces of competition enable the markets to monitor themselves effectively and the forces of demand and supply keep the markets in equilibrium, weeding out inefficiencies. Not even such catastrophic events as the failure of savings and loans institutions and the collapse of Long Term Capital managed to weaken the ideas behind free market capitalism.

When former US Treasury Secretary Hank Paulson who headed Wall Street Powerhouse Goldman Sachs before joining Bush Administration declared, “Raw Capitalism is dead.” (Serwer and Sloan, 18 September, 2008), he knew what he was talking about. He admitted that there is really no such thing as absolute capitalism because even though the markets do a good job of monitoring themselves but it is far from perfect. A minimum government oversight is necessary to avoid extreme financial disasters when the markets are overwhelmed by human emotions responding to severe panics and over reacting to bad news and expectations. The only way markets could be absolutely trusted to monitor themselves would be if humans were perfectly logical creatures. This is the only way markets would be really efficient even though market efficiency theory has a large following. According to market efficiency theory, it is not possible to beat the market returns over long period of time.

This is where they clash with those who contend that markets do a good job over long periods but they are far from perfect. This position is especially supported by value investors whose most famous member is Warren Buffet. In their defence, value investors say that if there was really no way to beat the market over long term then someone would explain the success of numerous prominent investors such as Warren Buffet, Bill Miller, Michael Price, Seth Klarman, and others who have consistently beat the market over long periods of time. Not surprisingly, most of the support for market efficiency comes from those in academia where as the practial investors with strong record often doubt the validity of such a position. The later group seems to prevail in the light of events that led to the financial crisis.

The foundations for financial crisis were laid after the 9/11 crisis when the Fed lowered feds fund rates to create liquidity and ease market concerns. The cheap supply of money led to increased investments many of them were risky. Loans were extended to almost every one even those with low credit worthiness and this is what created the housing boom. The historical record of real estate market led to delusion that housing market is somehow exempted from the laws of demand and supply and eventually this excess supply led to housing bust. Investors misunderstood the concepts of diversification and assumed that the pooling of risk loans would somehow decrease the risk. But the fact is that they were only increasing the risk magnitude by pooling together loans that all belonged to the same risk class.

Noone questioned the logic behind financial instruments because the pressure was to compete with competitors showing huge paper profits and enjoying soaring market capitalisation. The human emotions especially greed prevailed over reasoning that eventually led to financial crisis and almost threatened to collapse the US economy if it were not for government bailout. It’s true that Lehman Brothers and Bear Stearns were allowed to collapse but without government intervention, it was just a matter of time before Merrill Lynch, Morgan Stanley, and Goldman Sachs follow the suit. Merrill Lynch survived by selling itself to Bank of America. If the financial crisis proved anything, it was the necessity of government oversight of the financial markets that often led human emotions prevails over logic due to blind puruit of profits. The crisis also revealed the interdependency of global financial system where its easy for crisis to spread from one country to another due to increasing levels of global trades. Thus, financial alliances are as important if not less than political alliance in the world we live today!

It also demonstrated that there is really no such thing as absolute capitalism as there is no such thing as absolute democracy. All nations are a hybrid of democracy and socialism though they are defined by the dominant political system. US is a democracy yet programs such as social security and medicare systems have socialistic elements to them. This is because profit is the primary motive for the participants of the free markets and thus, non-profitable social welfare doesn’t seem an appealing activity. Similarly, there is really no absolutely free market system possible because with regulations, markets have the tendency to regard the social costs of their behavior in the pursuit of monetary profits. This may be the message Hank Paulson intended to send that without atleast minimum government oversight, the markets are as capable of reckless behavior as they are of logical behavior. Though the financial crisis doesn’t reduce the importance of financial institutions to the stength of the economy, it does demand greater accountability on their part. The moral hazard of too big to fail will always be there thus, there is a greater need to monitor the actions of huge financial institutions that have the potential to threaten the whole economy all by themselves.

References

Serwer, Andy and Allan Sloan. “How Financial Madness Overtook Wall Street.” Time 18 September 2008. Print.