Why we need more capitalism, not less
Tents are pitched in front of St Paul's Cathedral on the third day of a protest to occupy the London Stock Exchange on October 17, 2011 in London, England.
October 24th, 2011
04:22 PM ET

Why we need more capitalism, not less

Editor's Note: Russ Roberts is Professor of Economics and Mercatus Scholar at George Mason University. He is also Research Fellow at the Hoover Institution at Stanford University.

By Russ Roberts, Foreign Affairs

The protesters are right about one thing: Washington has been coddling Wall Street. But they have missed the most important way that Wall Street lives off the rest of us. Programs like the Troubled Asset Relief Program of 2008 are red herrings. TARP did send $700 billion to Wall Street, but most of it has been paid back.

There is a much more important, albeit quieter, favor Washington has been performing for Wall Street over the last 25 years: When large financial institutions get into trouble, policymakers make sure that their creditors receive 100 cents on the dollar.

The economist Milton Friedman liked to point out that capitalism is a profit-and-loss system. Profits encourage risk-taking. Losses encourage prudence, which is just as important. Over the last 25 years, however, government policy has been laissez-faire when it comes to profits, and socialist when it comes to creditor losses. That is a very destructive cocktail. It has encouraged imprudent risk-taking financed with large amounts of borrowed money. When you subsidize recklessness, you unsurprisingly get a lot more of it.

The bailouts of large creditors - such as the 1984 rescue of Continental Illinois, the 1995 rescue of Mexico, and the 1998 government-orchestrated attempt to save the creditors of Long-Term Capital Management - sent a signal to large lenders that they might lose little or nothing if the investments they fund go bust. That in turn made lenders much less cautious, allowing financial institutions to use borrowed money, rather than their own capital, to finance the housing boom.

What Occupy Wall Street Gets Wrong About Inequality

Using borrowed money instead of equity lets you keep the upside for yourself. Such an arrangement is always appealing. But why did lenders accept such risks when they do not share in the upside, especially when the investments were increasingly risky? Part of the reason is that government created expectations that lenders might get their money anyway.

And they often did. When Bear Stearns went belly up in March 2008, the government did not let the firm go bankrupt. The Federal Reserve guaranteed the toxic assets of Bear Stearns to make the acquisition deal sweeter for J.P. Morgan Chase. But the real impact of the deal was that Bear's creditors - mostly other large Wall Street firms - paid no price for financing Bear's debt-financed mistakes. J.P. Morgan Chase honored those obligations 100 cents on the dollar. That reinforced the expectation that large firms could lend and borrow from one another with little or no risk. Reckless leverage is what made the crisis a crisis rather than something milder.

The received wisdom is that it was the failure to rescue Lehman Brothers that worsened the financial crisis. But it was the rescue of Bear Sterns' creditors that let Lehman continue to roll the dice, using borrowed money rather than pulling back and raising more capital.

The real cost to Main Street has not been the transfer of taxpayer money to Wall Street. The real cost to Main Street has been Wall Street's imprudent lending and investment, which led to lending trillions of dollars to build more and bigger houses. That was a bad use of precious capital. The incentives to invest wisely have been distorted. And we are all still paying the price for the collapse of highly leveraged firms.

This is not capitalism; it is crony capitalism. Occupy Wall Street's diagnosis of a parasitic symbiosis between Wall Street and Washington is correct. The coddling of Wall Street let borrowing get out of control, unnaturally enlarged the banks, and helped justify and fund bonuses that otherwise would have been much smaller.

The Fight for 'Real Democracy' at the Heart of Occupy Wall Street

But the top one percent includes a lot more people than just Wall Street executives who have been living large because of the opportunity to leverage investments with borrowed money. The top one percent included Steve Jobs, who grew fabulously wealthy by making the rest of us better off. The same goes for Sergey Brin and Larry Page, the founders of Google. These innovators make enormous sums of money, but the gains to the rest of us are even larger. Great innovators make the economic pie bigger.

The views expressed in this article are solely those of Russ Roberts.

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Topics: Economy • Protests

soundoff (29 Responses)
  1. Muin

    You could have also mentioned the fact that Feds gave banks trillions in zero interest so that they can give back money quickly. If a bank is that broke, you let it fall. We would have seen other big banks. Why do have to have those banks? What is so special about those banks? Right now government is intervening again to save poor home owners whose home is under water. This is just another bad intervention by government. Back in 2001, Government really couldn't afford tax cuts because there were massive social programs underfunded in books. I don't know U.S government is in this viscous policy of one bad policy after another. Repeal of glass stegall act, tax cut, free money for banks to name a few.

    October 25, 2011 at 12:22 am |
  2. WeNeedChangeNow

    Cause and Effect
    • Democracy breeds freedom
    • Freedom breeds capitalism
    • Capitalism breeds Wall Street
    • Wall Street breeds greed
    Thus, Democracy breeds greed.
    Greed breeds collusion of the rich and powerful (1%)

    Unfortunately, OWT champions freedom.
    Thus, OWT will inevitably lead to no change whatsoever because democracy/freedom breeds greed.

    The OWT movement needs to more radical.
    The OWT movement should aim to ABOLISH democracy and capitalism.
    The OWT movement should aim to create one-party socialism.
    • Socialism breeds control
    • Control breeds equality
    • Equality eliminates class classification (i.e. 1% vs. 99%)

    Our Fouding Fathers would never have succeeded if it did have the radical idea to revolt. Now, this is our turn to act on the next radical idea – abolish democracy and capitalism because they will inevitably lead to our ruins.

    October 25, 2011 at 1:02 am |
    • Dominick

      Hahahaha! You honestly believe that? Socialism leads to control, control leads to dictatorship, dictatorship leads to greed for money and power, and too much governmental power in the hands of one person. You, sir, need to research politics more.
      "Capitalism" does not create greed; not real capitalism that is. You people think capitalism is government regulation over businesses and, well, pretty much everything that is done now. No, it's not. Capitalism is a free market economy where supply and demand regulate price, and the people regulate business. We bloody Americans have gotten so accustomed to the government doing it all for us, we've become too lazy to do anything ourselves. In a true free market society, if a company isn't giving workers their rights or high enough pay, guess what the masses do: they boycott them. They don't wait for some stupid politicians to regulate, they do it themselves. Seriously, I'm not joking when I see you need to read into the real definitions of politics and study them. I'm 17, been studying politics for 6 years. Political, social and economic freedom create the best and most prosperous societies. Just to throw it in there, we have a socialist-capitalist system. The socialist aspects like business bailouts and welfare to everyone allow people to take advantage of the system, abuse it, and throw the natural equilibrium off. That's something I also just recently learned in my California required senior Economics class. Thank you and I bid you ado.

      October 25, 2011 at 9:29 am |
      • mo

        17! wow, i have hope! keep studying, Dominick!

        October 25, 2011 at 9:31 am |
      • B

        Wow! Loved your response...You have given me hope that young adults are willing to speak with some sense! Keep up the good work.

        October 26, 2011 at 8:14 am |
    • mo

      yes, socialism has worked so well before. and the people are so happy living under it. why don't you talk to immigrants from socialist countries and ask them why they moved here.

      October 25, 2011 at 9:29 am |
    • beowoofwoof

      Give me messy capitalism anytime. History shows that your "Utopia" would have it's elite 1%ers.

      October 28, 2011 at 7:58 pm |
    • Natassia

      How naive. There is greed under every and any kind of system because greed is a trait every human must battle within themselves.

      November 5, 2011 at 7:20 pm |
  3. j. von hettlingen

    More capitalism doesn't hurt! The protesters are criticising corporate greed and their fat cats!

    October 25, 2011 at 8:33 am |
    • Greg

      On the contrary, I believe the central message was that the collusion of corporate and governmental powers have created a system where the people who are not involved in either no longer matter (which would make us inherently undemocratic). That message has nearly unanimous support where the idea that one person has more greed than another lacks traction amongst many Americans (can anyone honestly say someone else has more greed than their peers, how can that even be measured? Sure, our priorities are different, but greed is nearly equal among all people. Some people are driven for money, while others want to uphold their image with honor, but all are controlled through greed, no?)

      October 25, 2011 at 1:27 pm |
      • j. von hettlingen

        True, every economic system fails, if ethics are ignored. Capitalism without the excessive motivation of profit wouldn't be bad for a society.

        October 26, 2011 at 8:07 am |
  4. OBC

    Wall Street style capitalism happened in BRICS countries are called corruption.

    October 25, 2011 at 9:57 am |
  5. mark o. david

    Just what socialism do you want to get rid of?the police?military?firefighters?teachers?public roads?National parks?StateParks?state collages?homeland sec.?FBI?CIA?City,state,federal government?FDA?NOAA?NASA? Oh I know! welfare,that MUST be the socialist PROBLEM!Get rid of Social Security? medicaid?We certainly CAN'T do without Farm subsides or Corp.tax breaks or Federal bank bail out bonuses or a free Congressional Health care package.Did I miss anything?

    October 25, 2011 at 1:13 pm |
    • S. lutz

      Yes...you missed that you cannot spell. State "collages"?????I think you need to visit college Sir. Also, social services which you listed and Socialism are two different things. I think you are very unaware of what you are saying.

      October 25, 2011 at 2:48 pm |
      • mark o. david

        Is that all you got?social services ARE socially funded.Do you get that part.And the spellin don't count unless YOU do not have a point I am gessin

        October 25, 2011 at 3:56 pm |
    • Michael

      Yes we can start with military cuts, FDA, dept of energy, dept of education, homeland security, EPA, nasa is already defunded. State parks, state colleges, state and local programs are up to those localities NOT the federal government!

      October 26, 2011 at 9:48 pm |
  6. harmonynoyes


    October 25, 2011 at 5:33 pm |
  7. harmonynoyes

    when you feature a person as just an object, a symbol, you are dehumanizing them , so you can use them for whatever you want. You might call this freedom, I call it cruel usury, and I'm not buying it,or buying into it. Yes i do put myself above it , and that's my right.

    October 25, 2011 at 6:01 pm |
  8. harmonynoyes

    and to all the pro science anti religion people out there, I'm not just a symbol, a number, or a chemistry project;

    October 25, 2011 at 6:24 pm |
  9. harmonynoyes

    the profit motive is not the highest
    we make and sell things, find out they aren't good for us, and yet we make more of it and try harder to sell it
    why - profit motive , who promotes this

    October 25, 2011 at 6:38 pm |
  10. GOPisGreedOverPeople

    We don't have capitalism here. We have Corporate Fascism.

    October 26, 2011 at 9:02 am |
    • Michael

      It is in both parties not just the GOP! The dems cozy up to the green companies, the GOP to the oil companies...the true free market candidate is RON PAUL!!!!

      October 26, 2011 at 9:53 pm |
    • Occupado

      I work for a fascist corporation. I have a brand new car, a nice home, a big, fat 401k, my mortgage isn't under water, I eat out three nights a week, I don't owe anybody money and I sleep well at night.

      I didn't know I was being exploited.

      October 27, 2011 at 7:17 pm |
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