Monday, September 24, 2012

Short Sellers: The crony capitalist's enemy

There are a lot of ways that opponents of capitalism don't understand how important financial markets are to the way a healthy economy functions. They see people who sit in an office or work on the floor of an exchange as parasites on the system, instead of productive members of society like construction workers or people working on an assembly line. With a construction worker (at least when he isn't leaning on a shovel), it is easy to see the product of his labor, what he is contributing to society. Its not quite so easy to see with a stock broker or financial consultant.

But financial markets are VERY important to a smooth running modern economy. Many economists have explained how speculation helps to coordinate the use of resources and stabilize prices. During a harvest, speculators buy up grain when supplies are abundant and prices would otherwise be low. This provides the farmers with higher prices. But then the speculators save the grain for later in the season, keeping it off the market so it will be available when grain supplies would otherwise be scarce.

It is hardest too see the benefit to the whole economy of having short sellers. I myself have trouble getting around the fact that short sellers are betting on the destruction of value. Emotionally, this, to me, seems creepy, destructive, sneaky, even dishonest. But the more intellectual parts of me have to acknowledge the great good that has been done by short sellers. What they do is reveal the rot in our economy, and speed the healing process.

Take Enron for example:  regulators should have known that something was wrong, but they turned a blind eye. It was speculators who uncovered the corruption, made a big profit selling the company short, and demonstrating to the world that the company was, in fact, an empty shell. The short sellers did not destroy Enron. It was already hollowed out and destroyed. We didn't know it, yet.

What the short sellers did was speed the process by which people came to realize all this.

Without the profits available to short sellers, there is not as much motivation to do the research, take a really good look at a company's books and see if it is really as profitable as people think it is.

Sunday, September 16, 2012

The elephant and the blind men

Whenever discussion comes up about the 2008 financial crisis, and I end up asking, again "what free market?", I tend to think of the story of the elephant and the blind men. Everyone knows the story. A group of blind men want to know what an elephant looks like, so they find one, and all of them go to touch it, to feel it and find out what everyone is talking about. One touches the elephant's trunk, and says that an elephant is like a snake. Another is at its ear and says an elephant is like a big banana leaf. A third is at one of its legs and says that an elephant is like a tree trunk. The blind man at the elephant's tail says that it is like a rope, and so on.

A large number of free market observers have each pointed out different aspects of government intervention which helped create the housing bubble and the financial collapse of 2008.

Thomas Sowell, in his book The Housing Boom and Bust, describes land use regulations such as "open space" laws and limits to the height of apartment buildings as the cause of localized high housing prices which government officials all the way up to the White House mistook for a national problem, which they tried to solve with such things as Bill Clinton's "National Homeownership Strategy".

Thomas Woods describes the role of the Austrian Theory of the Business Cycle (ABC) and low interest rated from the Federal Reserve in Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse.

Daniel Henninger explains the role of things like deposit insurance in affecting banks' behavior in regards to risk in Welcome to 'Moral Hazard'.

Others show how deposit insurance was created to fix problems that were caused by previous regulation:

A Perfect Stormof Ignorance

Other observers have implicated the SEC's role in turning our rating agencies into a virtual monopoly, requiring banks to use Moody's, S&S, and Fitch, the three big ones, in order to invest in securities:

A Government Failure, Not a Market Failure

End the Credit Rating Monopoly

There is probably a whole lot more I can list, if I just keep digging. No economist, conservative or free market politician or commentator, or blogger has named all the regulations which helped to contribute to the housing bubble and financial crisis of 2008. To fully understand it, or at least try to, you need to read many different sources, each of which provide a small piece of the whole picture. 

For those who love free markets, the housing bubble and the collapse of 2008 provide a target rich environment for blaming government for its interference in markets.