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Credence in Capitalism

Posted on: October 8, 2008 - Email Article - Printable Version

Adam Brown

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My interest in writing this piece was sparked by a spirited debate with a fellow Bullish Banker regarding the implications of the financial crisis on the next President Elect. Upon watching the debates, it is clear neither candidate wants to address how such a financial bailout (and overall financial deterioration) will affect their campaign promises. The bottom line in all of this financial noise is that the standard of living must come down. The American consumer (yes with the help of the investment banks) is now being disciplined for their largesse over the past several years, which in the end is what drove speculation in many of the markets that have now become the problem. The deficit at the national level was not the problem as it turns out; it was the deficit at the consumer level.

To borrow a quote from one of my favorite conservative authors, Wick Allison, “Conservatism to me is less a political philosophy than a stance, a recognition of the fallibility of man and of man’s institutions. Conservatives are…doubtful that government is wiser than its citizens, and always ready to test any political program against actual results.” Capitalism encourages innovation on the grounds of economic growth. The problems with the freedom of capitalism are evident when consumer and investor imprudence run rampant. The policies enacted to curb the financial crisis will usher in an era of regulation made distinct by markedly more liberal economic policies. On the one hand, this regulation will avoid the boom-bust cycles that have characterized the past twenty years. It will keep investor and consumer discretion in check. My fear, however, is that the precedence set by Paulson’s interventions supposes a government wiser than its citizens, and the growth stimulated by capitalism will be brought to its knees.

Cash or Credit?

I’ve discussed in a previous post the massive deleveraging that is taking place within the financial institutions. Indeed, it was this forced deleveraging that brought down the last two investment banks, Goldman Sachs [GS: 90.645, +1.865 (+2.10%)] and Morgan Stanley [MS: 18.47, +0.85 (+4.82%)]. However, it seems the deleveraging at the consumer level has gotten shuffled under the carpet. American’s have been living off of borrowed money to pay for autos, consumer goods, and most especially housing. The Federal Reserve reported today that consumer credit contracted by almost $8 billion in August. It is the largest decline since the recordkeeping began in 1943. Clearly Americans have put away the credit cards and reexamined their ability to pay for anything beyond their current income stream. Look no further than the performance of Visa [V: 55.34, +1.52 (+2.82%)], which derives its revenues on a per swipe basis.

Most of the limelight has shone on the problems plaguing the large financial institutions. While the economic indicators are easy to push aside in all the calamity, let’s not forget that the underlying consumer situation is very weak. Nonfarm payrolls declined 159,000 in September, more than double the average pace throughout the year, and unemployment held at 6.1%. The labor report last week was an obvious indication of a weakening domestic economy. The ISM data dropped to 43.5 (consensus 49.5). Auto sales hit a 16 year low. Today, Bernanke painted a very weak picture of the economy. Later this week we receive trade balance data that gives investors color on how foreign demand is holding up. Recent European struggles suggest this number will also be lacking.