* Scott Burchill

* October 8, 2008

Free market failure.

A jittery world is questioning the fundamental tenets of the economic system.

AS THE world's financial markets have unwound, three simultaneous crises have become apparent. The fallout goes beyond the immediate effect on either individuals or on the workings of the global economic system to call into question the viability of modern capitalism.

The first crisis relates to confidence. This is a deeper problem than the normal investor's gamble on when to sell stock in a volatile market. Many workers, worried about their superannuation holdings, wonder why their funds' managers have been paid so handsomely for such a poor performance. They also question the value of the ratings agencies such as Moody's and S&P, which have misled them so badly.

At the centre of the crisis of confidence is a failure of leadership. As the tortuous passage of the $US700 billion ($A969 billion) plan to buy up toxic debt illustrated, neither the lame duck in the White House nor those on Capitol Hill have either the financial or political capital to lead the world economy out of this mess. Public opposition to bailing out rich, incompetent bankers, approaching elections and ideological puritanism have resulted in a paralysis of policy.

There is little confidence, even on Wall Street, that the Emergency Stabilisation Act mark 2 will live up to its name.

The second is a systemic crisis. How can the collapse of the global financial system be averted and how did it become so anarchic? Bail-outs, buy-outs, arranged marriages and infusions of capital have been the initial responses of central bankers and treasury officials. But they are making policy on the run without any clear understanding of the new challenges they will face tomorrow.

Wall Street has a vested interest in overstating systemic risk and has convinced Washington that in an election year Fannie Mai, Freddie Mac and AIG needed to be saved because of the system-wide effects of their collapse. They were less successful in persuading the Bush Administration to bail out Lehman Brothers and the investment banks that have fallen in its wake.

If you are big enough to bring the system down with you, it seems capitalism can be risk-free. Questions about moral hazard and commercial risk remain embarrassingly unanswered. What we are witnessing is the privatisation of profit and the socialisation of risk.

The systemic crisis has been sparked by private avarice, the need for instant consumer gratification through credit, and reckless lending practices by private investment banks. It has been underwritten by complex, innovative and opaque financial instruments used by hedge funds (such as collateralised debt obligations, credit default swaps, binary options, etc.), which defy understanding, let alone regulation. Relentless competitive pressures (there is no copyright on financial instruments, hence the constant demand for innovation), a naive faith in a self-correcting market, and short-term speculation rather than long-term investment, have driven the system to the point of collapse.

The third, and most serious, is a legitimation crisis. What will happen if, as a consequence of this financial disaster, there is a withdrawal of mass support for the existing economic order? There may be no viable socialist alternative with any credibility, but the loyalty of the population to an increasingly crisis-prone economic system will be severely tested.

Governments will need to restore public confidence in a system that is beyond stable management. After this debacle, few investors will be pacified with mantras about "market corrections", the "fundamentals" being "sound" or the science of "risk management". We are living with the consequences of deregulation, liberalisation and globalisation — which we were told were both inevitable and desirable. Opposition to corporate globalisation and unfettered market forces was said by both Labor and conservative governments to be irrational. It doesn't look that way now.

One response to the legitimation crisis has already appeared. Nostalgia for the free market heydays of Reaganism is now evident among economists and much of the business press, who call for a strict adherence to free market principles. It's ideology based on mythology.

First, Reagan was the most protectionist president in postwar US history. As a champion of military Keynesianism, he called on the Pentagon to create the "factory of the future" to teach advanced Japanese production strategies to backward US management, founded Sematech to rescue the US semiconductor industry, bailed out Continental Illinois (then the largest bail-out in US banking history), and vastly expanded the military sector with boondoggles such as "Star Wars".

Second, US governments have always been deeply involved in the nation's economy. Anyone employed in agribusiness, the military (or the industrial sector that services it), who uses a computer and the internet, flies in a plane or takes medicine, can thank the investment, subsidies and guaranteed markets provided by the US taxpayer. American capitalism, defined in free market terms, has always been a myth despite the economists, politicians and businessmen who pledge their faith in it.

Comparisons with earlier economic crises, including the Great Depression, are a limited guide to alleviating the problems we now face. There are no obvious solutions to such unprecedented challenges and simultaneous crises. But if nothing else emerges from the maelstrom, the role of the state in rescuing American capitalism from its internal contradictions will be the final antidote to free market hagiography.

Dr Scott Burchill is a senior lecturer in international relations at Deakin University.

http://www.theage.com.au/opinion/capitalism-in-crisis-20081007-4vt5. html?page=-1