The case for capitalism

Judy Shelton:

"Le laisser-faire, c'est fini."

It was French president Nicolas Sarkozy who actually uttered the words, but you could draw the same message from watching the televised debates in the United States at both the vice-presidential and presidential level. You know that America's founding economic philosophy is in deep trouble when candidates for our nation's highest office refer easily to "Wall Street greed" and "predatory lenders" to explain the global financial crisis. And those are the Republicans.

Where are the champions of free-market capitalism? Someone needs to remind us all that two great works were published in 1776, both representing game-changing advances in human freedom: The Declaration of Independence, authored by future American president, Thomas Jefferson, and "The Wealth of Nations" by Scottish economist Adam Smith. Both embrace the social wisdom of individual liberty; both extol the importance of personal responsibility.

These days, it seems difficult to defend the efficacy, let alone the morality, of an economic approach to human interaction that is now blamed for having put the entire global economy at risk. But that is exactly what we need -- most importantly, from America's next leader.

Sometimes it takes an outsider to help us gain perspective. Deep within the condemning speeches delivered by Mr. Sarkozy, both in New York and Toulon, are the grains of a new approach to capitalism that should give Americans reason to hope, not only for economic salvation but for a sense of redemption on a deeper level. France's president held out the possibility that all is not lost, that we can fix what is broken. "The financial crisis is not the crisis of capitalism," according to Mr. Sarkozy. "It is the crisis of a system that has distanced itself from the most fundamental values of capitalism, which betrayed the spirit of capitalism."

It is a distinction that could make all the difference. The world at large is drawing lessons from this economic crisis that will influence the political destiny of mankind. Mr. Sarkozy is trying to harness the collective dissatisfaction into a bold call for global reform. He is calling on world leaders to hold a summit before the end of this year to lay out proposals for a new approach to international financial and monetary relations. It could be the world's biggest boondoggle -- or the dawn of a new beginning for capitalism.

If we are to build a new foundation for global financial and monetary relations on the scale of the Bretton Woods Agreement conceived as World War II was still raging, we must summon the intellectual depth and political will that can only derive from a strong sense of moral purpose. Give credit to Mr. Sarkozy for demonstrating leadership in attempting to salvage what we know is true -- that democratic capitalism is the best hope for mankind -- while jettisoning the abuses and fraudulent practices that have distorted the outcomes of free-market competition. The French president's call for a global summit should be heeded.

What are the basic principles that we can forge together toward this "true capitalism" that Mr. Sarkozy has described, this market economy that utilizes the power of genuine competition to serve the needs of individual producers and consumers? It is a capitalism that accords primacy to the entrepreneur -- that compensates hard work, innovative solutions, stalwart commitment and personal discipline. The values that define the character of individuals should find expression in the policies that underpin the legitimacy of governments. Honest capitalism requires the following:

- Free-market clarity. Consumers must be able to properly judge the inherent value of goods brought to the marketplace if markets are to function properly; this applies to financial instruments as wholly as it does to products and services. When the trade-off between risk and return is obscured by an implicit government guarantee -- as exemplified by Fannie Mae and Freddie Mac securities offered with a "wink" from Uncle Sam to eager purchasers around the world -- the consequences can prove extremely damaging. False advertising leads to compromised market outcomes; it constitutes a betrayal of the consumer.

- Monetary integrity....

- Financial validity....

- Regulatory responsibility....

- Entrepreneurial opportunity....

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There is more.

On the regulatory responsibility front, a word on behalf of the SEC is in order. The major focus of security regulations is on protecting the integrity of the market place. However, most of that effort is directed toward retail customers and not toward sophisticated institutional customers who are presumed to have the ability to analyze risks and make investment decisions without the level of oversight of the retail market. Indeed this presumption is built into the securities laws which exempt much of their business from direct regulation.

What happened in this situation is that the presumption of sophistication proved invalid when it came to analyzing the risks in many of the mortgage backed securities. What these sophisticated investors failed to comprehend was how the Democrats interference with sound lending practices had skewed the mortgage market. The securitization of mortgages also insulated lenders from some of the consequences of their bad lending practices forced on them by Democrats. They also failed to comprehend how securities that were supposed to increase the liquidity for the mortgage market would wind up decreasing the liquidity for all credit markets.

If there is to be a major change in regulatory supervision of the market, the regulators will have to look at the validity of the assumption of sophistication of institutional investors as well as the advisability of permitting the sale of mortgage backed securities sliced and diced into packages that distort the inherent credit risks of dealing with investments in imperfect markets through instruments that are traded in what is usually a more perfect market place.