Has Capitalism Failed?

If you look in a dictionary, the definition of capitalism goes something like this: “An economic system in which investment in and ownership of the means of production, distribution, and exchange of wealth is made and maintained chiefly by private individuals or corporations operating in a free market, especially as contrasted to cooperatively or state-owned means of wealth. The creation of ideas and taking advantage of conditions to provide services or supply goods to the free market via privately controlled production and consumption, the success of which is dependent upon the accumulation of profits gained in and reinvested in a free market”.

“Capitalism has failed” is a popular outcry today but those who believe this have misread the causes of our current economic conditions. If we consider our position today from a macro perspective, it is quite apparent that our economic distress has been caused by a failure of our regulatory framework, not the failure of capitalism.

There are several blatant examples of these regulatory failures: 1) the failure of the SEC to investigate Bernard Madoff after several acusations of his operation being a ponzi scheme over a 15 year period, 2) the failure of bank regulators to understand the risk position of the institutions they were charged with overseeing, 3) the Fed’s ruinous interest rate policy under Alan Greenspan during 2002-2005 during which interest rates were kept too low for too long, 4) a failure to regulate the credit default swap market, the ramifications of which are still unknown to most on The Street and off The Street, and most importantly and outrageously, 5) the absolute collapse of economic policies in favor of ad hoc “deals” which are more politically influenced than economically influenced.

Let’s be clear, government non-performance is the reason for our current economic circumstances, not the failure of capitalism. We should not be surprised by this as history has shown us the US has a long tradition of regulatory failure under all administrations.

In the fall of 2008, the Treasury and the Federal Reserve were empowered to take actions which threw out longstanding rules of economic behavior. As the US transitioned from longstanding policy to ad hoc decision making, predictability and transparency disappeared in a matter of weeks. Decisions were made in a matter of hours regarding the fate of companies. Moreover, these decisions were made with limited and poor information.

The result was that the politically blessed received billions but these actions have produced disasterous results. Hundreds of billions of taxpayer dollars were wasted, trillions of wealth were destroyed and 4 million jobs have been lost……..so far.

Ad hoc decision making is not how things should be. In the US economy, winners and losers should be determined based upon the old fashioned principles of 1) satisfying customers, 2) controlling costs and 3) constantly adjusting to changing markets. Today, we have devolved into a nation similar to Russia or Venezuela where your success is predicated upon your political connections rather than your economic ability.

In order to have a prosperous economic system, we must have certainty, transparency and people must win or lose based upon economic ability not political ability. When we saw rules replace by fiat, we saw investors and consumers move to the sidelines in droves.

To say that we have witnessed, since the fall of 2008 (which encompases both Republican and Democratic administrations), the most abysmal economic leadership since the 1970s era of wage and price controls is not an overstatement. Economic analysis has been thrown out the window because the government has replaced the precepts of economics with government mandate.

There is, however, a reason to be somewhat optimistic. While Hank Paulson was an ad hoc deal junkie, Larry Summers and Paul Volker, two of the present administration’s key economic advisors, are policy oriented. whether we love or hate the policies, we must remember that policies are better than deals.

Capitalism has not failed, our elected decision makers have.

30 Responses to “Has Capitalism Failed?”

  1. 1 Geoffrey Silverstein June 4, 2009 at 10:42 am

    One thing to keep in mind is the one-sided nature of compensation in the financial markets. People get paid for producing, but in the case of financial assets, this compensation is upfront, whereas the risk of loss is on the back end. If compensation were tied to the IRR of an investment and paid out upon exit, the interests of investors and the professionals that advise them would be aligned. Too often, traders, salespeople and the rest get their money up front, with investors getting stuck holding the bag.

  2. 2 Justin McCarthy June 4, 2009 at 11:12 am


    On point, but I would take it further. Not only is our current economic crisis a function of failure of our central government in its regulatory role, it is the consequence of the government’s attempt to harness (or pervert) capitalism to acheive overt policy objectives.

    Since the demise of the USSR, our political leaders have been hell bent on global integration at any cost. Not an unworthy goal. But, much of the de-regulation or lack of regulation had the intent of opening up the capital pipelines and juicing the American consumer to help integrate China and Southeast Asia into the grand American co-prosperity sphere by permitting them to sell into our markets.

    This is nothing more than a super-charged version of what we attempted to achieve after WWII with Europe, Japan, South Korea, Taiwan, Etc. However, to economically integrate two to three billion new entrants took the equivilent of economic crack cocaine administered to our economy, capital markets and consumers.

    Of course, this analysis is simplistic and the drama highly nuanced and there are many co-actors and co-beneficiaries in this play. But, the executive producers can be found in Washington, DC with the directors on Wallstreet and London.

    Remember, Ludwig Von Mise’s axiom; “Central governments are always trying to find ways of artificially reducing the cost of capital”, to achieve thier ends and retain power.

    Jusitn McCarthy

  3. 3 Lawrence Tobe June 5, 2009 at 9:17 am

    True, but the capitalist bought the politicians. A huge example is how Sandy Weill at Citibank gave enough money to a politician, such as Robert Rubin, Secretary of the Treasury under President Clinton to dismantle the Glass-Steagall Act. That is a blaring example of how Capitalism does not work. Well, it worked for Corporations until you bleed all the little people out of money, well if you know anything about history what follows is a Depression. And yes, when Robert Rubin left politics he got a corner office at Citibank.
    I’m just an Architect and consider myself a layman and I would have to say you can blame the Capitalist for they were the architect/engineers that built this house of cards that have become so destructive to the average American.

  4. 4 savage64 June 5, 2009 at 4:29 pm

    Oh, this is just so much nonsense. It’s all the government’s fault? Those banks weren’t failing because of poor investment decisions? GM was done in because the government insisted it build mediocre cars? GGP didn’t leverage itself to the eyeballs? Personal connections were of no significance to economic success for the last 200 years? Capitalism encourages transparency?

    What has this guy been smoking?

  5. 5 John Terando June 5, 2009 at 4:32 pm

    I could not agree more. As President of one California’s oldest homebuilding familys firm, I can first hand attest to the devastation caused by the failed policy and oversight (probably a better term is undersight) the governmental agencies that were entrusted with those responsibilities and which failed to act on judisiously.

    We will continue to stay in the business, but we will now have to not only prepare for the challenges of a normal free market, but try to anticipate the whims of the political elite and their less then free market agendas!

  6. 6 rknakal June 5, 2009 at 6:37 pm

    Hi Geoffrey, Thank you for your post. I agree that the compensation structure misaligns objectives but that system is so fundamental to financial instruments that it will be a tough hurdle to get over to effectuate a change in that area.

  7. 7 rknakal June 5, 2009 at 6:39 pm

    Hi Justin, Thank you for your post. I agree with you that the producers are in DC and the directors are plentiful and are more numerous than we are probably aware.

  8. 8 rknakal June 5, 2009 at 6:47 pm

    Hi Lawrence, thank you for your post. There are many contributors to this mess but most of them operated within a system that was allowed and was legal. The ground rules were in place to keep things in check but the implementation of the rules failed. What is the point of having an SEC if they are repeatedly asked to look into “an obvious” ponzi scheme and fail to do so. It is just like calling the fire department to report a fire and then they just show up when the ashes start blowing away long after the fire has burned out.

  9. 9 rknakal June 5, 2009 at 7:01 pm

    Hi JD Nathan (Savage64), thanks for your post. I don’t mind when people disagree with me. I agree that the Government is not soley responsible for this mess. Others are culpable but much of the mess could have been avoided if oversight was implemented. Government objective (like wanted to force a homeownership rate which was higher than the free market would bear) led to abuses and people from many different areas taking advantage of the system. If you empower Fannie and Freddie to buy just about any piece of garbage because you want the homeownership rate to increase, wouldnt you think this would have outcomes that would have to be monitored carefully. The referees (government) failed, it is not that the game (capitalism)is bad. Capitalism is not perfect because people are not perfect. Sure, sometimes capitalism has a tough time but do you think Tiger Woods stinks because he does not win every tournament? If you believe socialism or communism are better systems, it is your right to think so. If you do, I would disagree with you……and I wont ask you what you are smoking.

  10. 10 rknakal June 5, 2009 at 7:02 pm

    Hi John, Thanks for your post. I wish you and your family the best of luck and hope that you emerge from this current market quickly and successfully.

  11. 11 rknakal June 5, 2009 at 7:06 pm

    JD, Also, GM (Government Motors) should have been allowed to go into bankruptcy long before it did. The union contract negotiated in the 1970s killed that company because it created a dynamic that was unsustainable. When the contract was negotiated there were 2 retired employees for every active employee. Today there are 10. They simply could not be competitive and should have gone chapter 11 long before Uncle Sam poured billions of our dollars into them.

  12. 12 FearNot June 6, 2009 at 10:42 pm


    The definition of capitalism (like virtually everythng else)seems to be interpreted differently by different people.

    #1 Those who beleive it to mean government intervention in any form is anathema to capitalism appear to argue the mear existance of a regulatory framework was cause for failure. From a practical perspective, I’ve never understood this perception since I’m of the opinion that capitalists are (perhaps be definition) going to do what is in their best interest) and if that means being greedy (thith seems logical) then they’ll be greedy. I’m proposing this as neighter good nor bad, just logical.

    #2 Those who presume a regulatory framework is necessary to protect investors from #1 above (I happen to fall in this category)tend to find fault in the regulatory system (not in it’s existence per se, but in it’s performance).

    My confusion comes from those who subscribe to #1 above, then when things go bad, find fault in regulation by prostulating it’s exeistance is cause for systemic economic faliure. They seem to suggest their is no potential for bad acts, criminal fraud etc. They point at the mis-application, non-application of regulation (again, purportedly designed to protect investors from free-market malfeasenece) as if regulation intended to protect investors/comsumers/people is more problematic (or perhaps probable) than the willingness of humans to misbehave.

    I’m not a big bible guy, but what I’ve read of it is pretty darn good (especially if it’s being applied as more of a human owner’s manual as opposed to a litteral translation). There are several references that (from my take of it) suggests any act committed by one person is proof that any other person is capable of commiting that same act. Whether the act is of great good, or great harm is beside the point. If we subscribe to that possibility, we must regulate human activity (our inflated prision populations seems to suggest we don’t have a problem acknowledging the ability of people to do wrong.

    the the they don;t seem to find fault in the malfeasenace as much as they do the system designed to minimize it whil, at the same time, condeming the mere existance of regulations as the cause for

  13. 13 John M June 8, 2009 at 9:02 am

    350 million people in the USA consume 25% of the Earth’s resources. 6 BILLION + live on this planet.

    The USA has lost almost all productivity to emerging markets.

    The only thing left to export to the world are ponzi-like poorly rated financial investments which are worthless.
    Without this export, we have nothing to offer but our land.

    Any recovery in the US economy will be accompanied by $200+ oil and very expensive imports.

    We can no longer rip-off the world anymore.
    The rest of the world is catching up. If we lose reserve status, we are a banana republic. There is nothing special about the US other than it’s dollar reserve status.

    A hyper-inflated and weaker dollar can help us export to the world but Americans will live like Europeans…more frugal and always concsious of every penny.

  14. 14 Danielle June 10, 2009 at 4:16 pm

    Greatly written article.

  15. 15 DayofReckoning June 14, 2009 at 1:16 pm

    If the economy were doing well, all of the sins would have been swept under the carpet and the scorecard would have been solely based on money. That, ultimately, is the problem. Money doesn’t quantify so many other issues relevant to a nation, corporation, community, citizenry and populace. Sometimes, when you are counting on it the most, the proverbial “invisible hand” slaps you in the face. God Bless America. We will survive this.

  16. 16 rknakal June 14, 2009 at 3:01 pm

    Hi Day-, thanks for your post. Capitalism may be out of favor for the time being and may be for another three and 1/2 years. Ultimately, capitalism will thrive. No other system can compare.

  17. 17 Will June 17, 2009 at 9:21 am

    Although I agree with the article, the author seems to let personal resposibility and internal corporate governance off the hook completely. The government failed to regulate, that is painfully obvious. However, it was the banks own greed and adherance to continued revenue growth at all costs that caused them to be over leveraged. The banks did it to themselves, all the highly educated and highly compensated analysts overlooked or ignored (I choose the second) the fundamental issues that assets were entirely over-valued and unsustainable. They sacrificed long term stability for short term gains, and it cost many companies and investors everything. Banks and investment firms were caught up in massive profits and started to loose sight of reality. Governement did not have anything to do with that.

    I am a very strong believer in personal responsibility, and saying that the governments’ failure to regulate is the cause of the current economic environment is like saying Smith & Wesson is responsible for all the murders in America. Government regulation is nessecary AS A RESULT of corporations and individuals acting out of self interest and ignoring the good of the whole. Bernie Madoff is the perfect example of this.

  18. 18 Alan Sharp June 17, 2009 at 11:14 am

    Mr. Knakal hits the nail squarely on the head. Massive government intervention has totally eroded the organic balancing nature of Capitalism. The basics of supply and demand have been denied with tax incentives, bailouts, tariffs, regulations to name a few. It is no longer an issue of whats good for the people but rather an issue of whats good for the Statistics. An economy that promotes and supports failure at the expense of the succesful will very likely suffer the consequences.

  19. 19 Bobbo June 17, 2009 at 2:30 pm

    Capitalism is a series of cycles, accompanied by “successes” and “failures”. The most destructive force in the economic galaxy is entrepreneuriam. BY DEFINITION, new innovation crushes part of the system that aren’t working. However, there most certainly were failures, as many contributors to this discussion have pointed out: regulation, greed, “irrational exhuberance”, etc.

    Possibly, albeit not perfectly, Obama’s reforms will create a superprudential oversight process and require reporting to improve transparency – not outright control – of both the banking sector AND the non-bank sector of the financial markets.

    Time will tell.

  20. 20 CountTheCost June 19, 2009 at 1:37 pm

    Capitalism is doing fine. Remember:

    “Capitalism without pain and loss is like Catholiicsm without hell.”

    We must take our lumps count our gains, losses, friends, enemies, and lessons, and move forward.

  21. 21 rknakal June 19, 2009 at 8:23 pm

    Hi Will, Thanks for your post. The point of my article was not to blame the Government as being singularly responsible for our economic woes. The point was that Capitalism is not a failure. In 1968 Denny McClain won 31 games for the Tigers. He lost a few but you still wouldn’t have wanted anyone else on the mound that year even though he had a few bad games. It is the same way with capitalism. Of course personal responsibility and corporate governance are important. However, self-interest is the cornerstone of entrepreneurship and while that may be viewed as a bad thing by some, it is the American way. That being said, many of the self-interested, profit minded real estate market participants are among the most philanthropic people around.

  22. 22 rknakal June 19, 2009 at 8:26 pm

    Hi Alan, Touche! Thanks for your post.

  23. 23 rknakal June 19, 2009 at 8:33 pm

    Hi Bobbo, Thanks for your post. Entrepreneurship is only destructive to the extent that good ideas from new companies will wipe out old obsolete companies. If this didnt happen, we would all still be driving around in model T Fords. Perhaps the automotive industry is a poor example at the moment but that is another conversation for another day. I do agree with you about one thing, time will tell….. when it comes to the current policies that are being implemented.

  24. 24 rknakal June 19, 2009 at 8:36 pm

    Hi Count, Thanks for the post. I agree with you completely.

  25. 25 CTodd June 22, 2009 at 12:40 pm

    Good article- thanks. Your post reference to Freddie and Fannie really hit the hot button for me. I am a legal advisor in the commercial real estate industry and we in that industry were marveling at the loans that were being advanced by Freddie and Fannie, and expected an implosion to result. Sadly, didn’t fully anticipate the collateral damage that would ensue.

  26. 26 rknakal June 22, 2009 at 12:54 pm

    Hi CTodd, Thanks for your post. Very few people anticipated what happened. We are living in unprecedented times.

  27. 27 Carl Todd June 28, 2009 at 11:10 am

    True capitalism did not fail. The failure was caused by the wolf (crony capitalism) in sheep’s clothing masking itself as true capitalism.

    Failure of unsuccessful ideas caused by poor market research, under capitalization and bad management, etc. is pure capitalism’s mechanizm to purge itself of inefficient and unneeded businesses.

    Crony capitalism corrupts the system by buying political protection that results in unbalanced trade and ruinous business practices that places the costs of those losses on society that except for the few that ran and manipulated those venture. The latter group also gained undeserved riches as well. This in part explains why we are rapidly becoming a two class society growing more in human numbers in the lower economic end.

    A historic note for those who forgot the definitions of the various forms of governments. Remember how Benito Mussolini described “Fascism”? “The perfect marriage between government and industry”. Need we say more on “Crony Capitalism” the one thing that Adam Smith and Karl Marks both agreed on was the devastating effects of it upon society.

    What is need right now is to stop the pay for play in government and stop sending our manufacturing technology overseas (along with our needed jobs) and create a tax system that creates a carrot and stick to effect a return home for employment and work out balanced trade agreements that protects the worker’s standard of living and nation’s environment on both sides of the trade agreements.

  28. 28 rknakal June 28, 2009 at 1:11 pm

    Hi Carl, thanks for your post. Your points are well made and difficult to argue with. It will be interesting to see how our entrepreneurial and business cultures develop over the next couple of years.

  29. 29 Carl Todd July 1, 2009 at 2:13 pm

    Madoff was a small potato piker. The big players that where directly responsible for a goodly portion of America’s and the world’s losses were the CEOs. of Moodys, Standard and Poors, and Fintch. If they did not rate all the junk that they did as AAAI so many who rely upon their ratings would not have invested in that failed junk and would still be viable to continue their business. Those three CEOs should be keeping Madoff company in jail for the 150 years.

    Oh, by the way – what did Grasso do to earn his watch dog fee of $190,000,000 a year?????

  30. 30 rknakal July 10, 2009 at 10:45 am

    Hi Carl, thanks for the post. Certainly the rating agencies had a huge hand in the meltdown. The funny thing is, part of the TALF 2.0 is predicated on getting new AAA ratings on CMBS. Who would rely on the ratings? The agencies need more transparency in the formulas they use to come up with their ratings. Grasso is a whole other issue……

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