# Problems with Capitalism?

1. Apr 10, 2015

### lavinia

More Documentation

Here are two articles - one a detailed study of the S&L crisis - which document the effects of deregulation of that industry during the 1980s and sent the country into recession by the early 1990's and cost the US taxpayer large sums to resolve the ruined S&L industry. The FED, in order to stem the recession and finance the resolution of failed banks brought the overnight rate from over 8% to 3% by 1993.

https://www.fdic.gov/bank/historical/history/167_188.pdf

http://www.dailyfinance.com/2010/07/03/financial-meltdown-vs-savings-loan-crisis-recession.

The S&L crisis is parallel in many ways to the recent real estate crisis, particularly in the wide spread of speculation and fraudulent practices in the quest for high returns and in its effect upon the economies of several states. The crisis is commonly called the "S&L Debacle" .

Last edited: Apr 10, 2015
2. Apr 10, 2015

### lavinia

3. Apr 10, 2015

### lavinia

More Documentation

Here are references on the speculative bubble in Japan during the 1980's that triggered an at least one decade recession (The Lost Decade) and some say two decades.

http://www.thebubblebubble.com/japan-bubble/

After World War 2 Japan instituted banking regulations that were stricter even than those in the United States. These regulations were part of a program to nurture the Japanese economy. The policy was considered to be successful but in the mid-1980's significantly because of pressure from the United States and Europe, Japan deregulated its banking system After 1985 the bubble took off.(See the referenced paper below).

There is an interesting paper written in 1992 by Kenusuke Hotta, a Managing Director at Sumitomo Bank, who strongly favors the deregulation. I could not figure out how to copy the link but it is called "Deregulation of Japanese Financial Markets and the Role of Japanese Banks" Occasional Paper no. 7 ,Occasional Paper Series
February 1992

4. Apr 10, 2015

### lavinia

More Documentation

https://www0.gsb.columbia.edu/faculty/fedwards/papers/Hedge_Funds_&_the_Collapse_of_LTCM.pdf

This paper reviews the collapse of Long Term Capital Management
It also has a review of Hedge Funds and their trading strategies.

It also covers the 1998 Russia default on a large amount of its Treasury debt and its cancellation of derivative contracts. This created a cascade of margin calls and asset devaluations. Basically, firms were forced to sell assets in order to meet margin calls thus causing a drop in prices which then triggered more margin calls and so on. Panic led to a flight to quality which widened yield spreads on risky assets generally for instance, B rated corporate bonds. Long Term Capital Management had huge leveraged bets on yields spreads. The spread widening destroyed it and I have heard nearly wiped others hedge funds like D.E. Shaw & Co. Here is a section of the article that discusses the "systemic risk" of its impending bankruptcy and the resulting bailout organized by the Federal Reserve Bank of New York.

" In early September 1998, LTCM advised the Federal Reserve Bank of New York of its impending difficulties. During the next few weeks, Federal Reserve representatives organized meetings of LTCM's creditors and met with LTCM partners to discuss the situation. On the evening of September 22, the president of the Federal Reserve Bank summoned more than a dozen top executives of the firms that had loaned money to LTCM to an 8 p.m. meeting and warned them that "systemic risk posed by LTCM going into default was 'very real'" (Siconolfi,1998). The next day a 16-member creditor consortium agreed to put in additional capital of $3.625 billion in exchange for 90 percent of the remaining equity in LTCM; ...." Last edited: Apr 16, 2015 5. Apr 10, 2015 ### WWGD Correlation, Causation? Didn't socialist countries achieve a similar gain in life expectancy (during the years of communism)? I am not arguing in favor of communism, but, how do you explain, e.g. that Cuba's life expectancy is 80.7 years for female, 75.9 for males (World Almanac and Book of Facts, 2015, p.768), similar for former communist block countries (I assume life expectancy does not turn on a dime, that , if the economic system is changed, it may take a long time for the benefits/consequences of this change to take effect.) ? Besides, capitalism as we know it today has not been in effect for 150 years. Weren't many of the main discoveries made before today's capitalism was in effect? Vaccination, much of the medicine used to prevent childhood death, etc.? How about the scientific discoveries. And there is the additional fact that most of the people who have ever lived, have lived in the last 150 years, so it makes sense that the more people that are alive (living longer), the more discoveries you have. And there were 100's of important scientific discoveries before the 1900's. And the Soviet Union had some of the best scientists in the world. You may even reasonably argue that a critical mass of discoveries had been reached by the time today's capitalism went into effect. Last edited: Apr 10, 2015 6. Apr 10, 2015 ### WWGD How is the oppression of descent the result of abandoning capitalism? Despite the repeated mantra by the far right that freedom, capitalism and economic growth go together, the examples of China and India belie that very clearly. Same with South Korea, which was under repressive regimes for a long time. I think part of the problem with communist countries is that they educated many of their people too well, and the educated tend to ask the difficult questions. Of course, it is also true that there were no jobs for them. Still, capitalism as we know it today has less than 100 years in effect; too soon to decide whether it works in a sustainable way. 7. Apr 10, 2015 ### lavinia More Documentation This 2012 Business Insider piece quotes Bill Gross, CEO of PIMCO which is one of the largest bond funds in America, who says that the economy is at risk of a Japan style "Lost Decade" by which he seems to mean an extended period of "slow growth" despite signs finally of some recovery in the housing market and resumption of bank lending. His arguments focus on the shape of the yield curve and the record low interest rate policy of the Fed which he says has been in place in order to bring down long term yields to stimulate the housing market. His arguments underscore the severity of the current slowdown and also the risk that ensues when possibly unsound attempts at stimulating recovery are implemented. I found his arguments interesting. http://www.businessinsider.com/bill...ed-is-taking-us-on-the-course-of-japan-2012-2 Last edited: Apr 16, 2015 8. Apr 10, 2015 ### lavinia More Documentation The 1987 Stock Market crash While the 1987 stock market crash had a relatively mild after affect, it is one of the early examples of the risk of the new unregulated leveraged markets that took off in the 1980's Here are two articles that discuss it, one by a contributor to Forbes Magazine, the other a Federal Reserve Discussion Paper. http://www.thebubblebubble.com/1987-crash/ http://www.federalreserve.gov/pubs/feds/2007/200713/200713pap.pdf Both of these papers discuss how leveraged trading strategies - in particular Portfolio Insurance and Index Arbitrage - catalyzed the largest one day drop ever in the market. They also indicate how the stock market - during the vaunted Reagan recovery - was bolstered by low interest rates, leveraged buyouts, IPO's, mergers, hostile takeovers, and a general investment euphoria. These were the days of junk bonds, Michael Millikan's$500 million dollar a year bonus, soaring P/E ratios and the advent of computerized trading of equities.

I have included a page of financial data history such as market prices, bond yields. P/E ratios etc for reference.

http://www.sniper.at/stock-market-crash-of-1987.htm

The crash seems to be attributed to panic that ensued after several things happened. Here is the description in the Fedeal Reserve Paper.

First, news organizations reported that the Ways and Means Committee of the U.S. House of Representatives had filed legislation to eliminate tax benefits associated with financing mergers (Securities and Exchange Commission (SEC) Report 1988,p.3-10). Stocks’values were reassessed as investors reduced the odds that certain companies would be take-over targets. Second, the Commerce Department’s announcement of the trade deficit for August was notably above expectations. On this news, the dollar declined and expectations that the Federal Reserve would tighten policy increased (Wall Street Journal 1987b). Interest rates rose, putting further downward pressure on equity prices (see Figure 2).

On Thursday, equity markets continued to decline. Some of this decrease was attributed to anxiety among institutions, especially pension funds, and among individual investors, which led to a movement of funds from stocks into the relative safety of bonds (Wall Street Journal 1987c). There was also heavy selling during the last half hour of the day amid heavier-than-usual activity by portfolio insurers (Brady Report 1988, p. 21).

Markets continued to decline on Friday, as ongoing anxiety was augmented by some technical factors. A variety of stock index options expired on Friday; price movements during the previous two days had eliminated many at-the-money options so that investors could not easily roll their positions into new contracts for hedging purposes. These developments pushed more investors into the futures markets, where they sold futures contracts as a hedge against falling stocks. Increased sales of futures contracts created a price discrepancy between the value of the stock index in the futures market and the value of the stocks on the NYSE. Index arbitrage traders reportedly took advantage of this price discrepancy to buy futures and sell stocks, which transmitted the downward pressures to the NYSE (Brady Report 1988, Study III, p. 12).

By the end of the day on Friday, markets had fallen considerably, with the S&P 500 down over nine percent for the week. This decrease was one of the largest one-week declines of the preceeding couple of decades, and it helped set the stage for the turmoil the following week (Wall Street Journal 1987d). Portfolio insurers were left with an “overhang” as their models suggested that they should sell more stocks or futures contracts (SEC Report 1988, p. 2-10). Mutual funds experienced redemptions and needed to sell shares (Brady Report 1988, p. 29). Further, some aggressive institutions anticipated the portfolio insurance sales and mutual fund redemptions and wanted to pre-empt the sales by selling first (Brady Report 1988, p. 29; SEC Report 1988, p. 3- 12). ...."

This is an interesting account and the entire event deserves careful study because it exhibits the dangers of an unregulated leveraged market. It shows how a price bubble driven by euphoria and leveraged speculation can be rapidly burst when the factors driving the bubble go away. This can be a change in tax law, a rise in interest rates, a bad economic report, and so on. It also shows how the use of financial derivatives - in this case futures contracts and portfolio insurance (which is a "replicated" put option on the stock market) - can magnify a decline into a crash.

An important thing to note is that with such a huge decline in stock prices, the stock exchange itself was at risk of breaking down . This is because stock specialists financed their positions in stock on bank borrowing using the stock as collateral The banks became reluctant to finance these positions because the stocks had lost significant value and there was huge risk still remaining. BTW: This sort of financing is common in securities markets. In Government bonds, the market for this type of short term - usually overnight - borrowing is called the Repo market.

http://en.wikipedia.org/wiki/Portfolio_insurance

Last edited: Apr 16, 2015
9. Apr 18, 2015

### Siv

I agree.
But I think there are plenty of examples of its imperfections.

The bad aspects of human nature need to be suppressed and discouraged. Thats the whole definition of "civilization".
Capitalism does just the opposite.

Going one step further ... and I know there will be cries of "Nazism" in response to this ... but I don't know why we should continue to live with this problematic human nature and struggle with its consequences. Its a taboo subject to even discuss attempting to improve/modify it. Just because it resulted in atrocities once, does not mean it should be a banned subject forever

10. Apr 19, 2015

### lavinia

In my opinion, one problem with capitalism as it is practiced today (and historically), is the way that central banks handle problems of economically weaker countries to pay debt. The solution is to roll debt over in return for "austerity measures" which force these countries into economic hardship. Paul Krugman has this article where he says that austerity measures not only don't work i.e. they prevent the debtor country from paying by slowing its economy but their harshness leads to political radicalism.

http://www.nytimes.com/2013/02/25/opinion/krugman-austerity-italian-style.html?_r=1

To me, the imposition of austerity is not intrinsic to capitalism so I consider Krugman's observations to be criticism of practice rather than theory.

Last edited: Apr 20, 2015
11. Apr 21, 2015

### lavinia

SIV a couple of questions.

What do you mean by "human nature"?
What are the bad aspects of it?

12. Apr 21, 2015

### Siv

Human nature is essentially the behavioural and psychological aspects of human beings, a lot of which helped our evolutionary journey.
There are common aspects to all human behaviour.
This is a very brief description to something that can cover libraries ....

Bad aspects - oh there are so many ... ethnocentrism, xenophobia, short term benefits at the cost of long term benefits, violence, rape, deception .... all these are innate traits.

13. Apr 22, 2015

### Czcibor

May I, by rules of the forum ask for some data to back up your claim? Because it starts sounding quite interesting...

Because I have limited luck being born in a communist country, and consider such claims in the same as a black person consider claims that apartheid wasn't so bad...

14. Apr 22, 2015

### Czcibor

One question concerning intellectual honesty of this topic. (I mean especially Lavinia)

Are we comparing RL capitalism with some idealised, hypothetical system? Because I may already solve your dillema. Any RL system would be worse than any hypothetical idealised system.

No I mean as fair idea - idealised capitalism vs. idealised alternative. But under such capitalism there are no market failures or market crash :D

Or we should talk about RL capitalism and compare its successes with RL "successes" of its contenders. Like the West vs. Communist countries. Or compare India vs. PRC from times of Deng Xiaoping, when communism was effectively started being jettisoned. Or compare India to Asian Tigers.

15. Apr 22, 2015

### Siv

Sure, Czibor. But which claim, precisely?
I had quoted E.O Wilson's famous "Great idea, wrong species."

16. Apr 22, 2015

### Czcibor

"capitalism is really not much better"

And we may try to compare let's say North Korea with South Korea.

17. Apr 22, 2015

### lavinia

I am not sure why I am suspected of intellectual dishonesty. Let's dismiss it as an unfortunate choice of words.

Many of my post were originally in response to a challenge to document the problems with unregulated markets and to show their long term effects. This is not a criticism of capitalism in all of its forms but of completely free unregulated markets. I argued that deregulation of financial markets was a key component of the speculative difficulties of recent decades. The effect of these difficulties is not trivial and in Japan it led to the "lost decade" and the CEO of PIMCO in another article I cited, warned of the risk of a lost decade in the United States. That is my point and I look forward to discussing it with anyone who wishes to take a rigorous view.

Of course, speculative markets are only one problem. I intend to discuss others, and have started to talk about "austerity measures". Paul Krugman's article is worth reading. He is a Nobel Laureate in Economics and a regular contributor to the New York Times.

As far as what systems work or don't work and what systems are better than others, I have no rigorous opinion on that. Nor have I seen a rigorous opinion in this thread. For instance, to say that the Soviet System collapsed ergo it was an inferior system is at worst ideology and at best a hypothesis to be examined.

Last edited: Apr 22, 2015
18. Apr 22, 2015

### Siv

When comparing with communism, it may be better, I agree.
But where is this (unwritten) rule that there should be no other options?

19. Apr 23, 2015

### Czcibor

I'd say that claim that claim "unregulated market" is bit risky. You pointed for example housing bubbles. Anyway why housing happens to be so expensive on those free market? Shouldn't those greedy speculators build something out of bricks and mortar instead of just building up bubbles?

Let me quote Krugman, who grudgingly admitted one interesting thing:

http://www.nytimes.com/2014/08/25/opinion/paul-krugman-wrong-way-nation.html

I fully understand idea - risky behaving financial companies and gov that puts supervision on them to limit risk. However to such picture don't fit well ex. US gov that by allowing mortgage deduction is actually encouraging people to take excessive debt.

The problem is that markets are quite often already strongly regulated, just from time to time in the wrong direction.

Who said that I use such claim?
Concerning SU collapse - the problem that's not one observation (that could have been caused by some random, unobserved factor.
So have you tried to compare GDP of countries on similar development level before and after testing this system you have no rigorous opinion? I mean North vs. South Korea (under Japanese rule north was actually more industrialized); China vs. Taiwan; West vs. East Germany; Spain vs. Poland (Roman Catholic countries, similar size: in 1950 Polish GDP per capita was a bit higher, in 1990 it had 30% of Spanish GDP)
How do you think, maybe a pattern emerge?

20. Apr 26, 2015

I am not defending communism, Czcibor, but didn't people in the Eastern block have most daily needs paid for by the state? Maybe doing a PPP (Purchase Power Parity) do $5,000 buy you the same in Madrid than in Warsaw (back then and now )? So, comparing maybe a$3,000 GDP per capita in the East vs more than $10,000 in the west, but in the East you are provided with housing, stable job, medical care? 21. Apr 26, 2015 ### Czcibor A bit tricky comparison: -$5000 for sure bought a lot in last days of Polish People Republic... according to black market exchange rate an average salary was about \$15
-how do you want to calculate a basket with adjustment for ration stamps? (especially in cases when you had ration stamps for stuff that was NOT accessible, even with ration stamps)
-how do you adjust that in the last decade shops were mostly empty and one was standing in a queue to buy anything? (sometimes it worked, sometimes not) (A realistic approach would involve calculate value of wasting a few hours per day on such staying in queue/shopping)
-how do you adjust for transactions done on black market or through a net of friends?
-how do you adjust for stealing in your place of work? (awful pathology at that time)

I may try to find you some data if you want.

22. Apr 26, 2015

### Czcibor

If data for 1990 (semi-free election was in late 1989), in PPP and adjusted 2005 dollars, are OK, then according to World Bank:

The data are a bit too optimistic for Polish consumer, as GDP was somewhat inflated by ineffective heavy and chemical industry, which was producing equipment for WW3.

But according to them we had 42% of Spanish GDP. (yes, there is a big dispersion in the data, pending on source)

23. Apr 26, 2015

### WWGD

My point is that while capitalism may be overall preferable to communism (at least as commonly-practiced) , it may be a good idea
to try to incorporate o capitalism some positive aspects of communism.

24. Apr 27, 2015

### Czcibor

Which one do you mean?

25. Jun 6, 2015

### lavinia

Some economists point to FDIC instance as a regulatory measure that led to the fall of the S&L's. This is a case of what they is call a Moral Hazard.Their point is that deregulation is not the problem per se.

It is true that FSLIC insurance remained after the S&L's were otherwise deregulated. But in this situation, FSLIC insurance became a free put option written by the US Government. So instead of functioning as a regulatory measure, it transmuted into a derivatives contract.

Before the deregulation of the S&L's FSLIC insurance worked fine in the context of a complete regulatory framework. From the 1930's until deregulation in the 1980's it worked fine. The same holds for Japan as I have described above.

On the other side of the coin, without a safety net such as FSLIC insurance there is risk of runs on financial institutions that lose investor confidence.

Last edited: Jun 6, 2015