Ten months,full circle

September 2008 was less than a year ago. Lehman Brothers collapsed. AIG got nationalised. Merrill got taken over. Washington Mutual disappeared.

Written by Jaithirth Rao | Published:July 11, 2009 3:12 am

September 2008 was less than a year ago. Lehman Brothers collapsed. AIG got nationalised. Merrill got taken over. Washington Mutual disappeared. Fannie Mae and Freddie Mac got nationalised. Most large US banks became subsidiaries of the government. Stock markets crashed. Credit markets froze. And as everyone admitted,the US plunged into the greatest economic crisis since the Great Depression. Where is the US today? Certainly not out of the woods. Unemployment is still climbing as the real economy feels the effects of the financial crisis with a lag. But guess what,things don’t seem to be all that bad. Credit markets are thawing; stock markets are a bit more buoyant; and wonder of wonders,three of the biggest institutions (JP MorganChase,Goldman Sachs and Morgan Stanley) which were in hock to Uncle Sam have repaid or are repaying the billions that they had borrowed. By all appearances,the worst seems to be over and the abyss into which the American economy could easily have fallen (30 per cent unemployment during the Great Depression,for instance) has been avoided.

When the Great Depression happened,it was fashionable for leftwing academics to predict the demise of capitalism. Instead,

the US got the Securities and Exchange Commission,the Federal Deposit and Insurance Corporation and Social Security,all institutions that were crucial to ensuring that the Crash of 2008 did not result in a repeat of the ’30s. This time round too we have had any number of gleeful commentators arguing that the US model is finished. If an economy can start to recover from such a massive shock in less than a year,surely it is by no means “finished”. In fact,one might make the case that such a model is pretty robust. Market capitalism may be messy and prone to excesses. Democracies may be messy and not efficient in their decision-making like the Politburos and High Commands of totalitarian states. But because they are inherently humble and they look at each crisis as an opportunity to learn,to correct course and to move on,they seem to emerge stronger rather than weaker from the setback.

Let’s take a look at the process. The clumsy working patterns of democratic legislatures result in key measures spending years lost in committees. And yet,a virtually lame-duck US Congress and a retiring US president pushed through the unprecedented TARP (Troubled Asset Relief Programme) legislation. Despite hiccups (it was first rejected),despite it being in the middle of a hotly contested election season,the law was passed. Money was lent out and as we have noted a lot of it has been returned in less than a year. The executive branch of government rose to the challenge of the crisis by stretching to the limits their powers and nationalising AIG. The process has worked well apropos of General Motors also. Here the traditional laws pertaining to orderly bankruptcies were used. The shabby treatment meted out to GM bond-holders is worrisome and one hopes this does not become a precedent which will be used to violate property rights in the future. But on balance,this crisis too seems to have been resolved,if only for the time being. The argument that democracies get paralysed in the face of crises has been shown to be the myth which it is.

What about learning lessons and medium-term reform? Here too the first steps are being taken. Fairly radical regulatory reform giving the Federal Reserve (itself created as a result of the economic crisis of 1912) expanded powers is now in the works. One can argue that more needs to be done. One can argue with equal credibility that over-reacting and doing “more” purely for cosmetic feel-good reasons is not smart. In the middle of this explosive crisis,there are still voices of sobriety that any new regulations should not eliminate risk-taking or innovation without which wealth-creation would come to an end. This is an amazing value that democratic discourse provides. An unelected know-all Planning Commission would not have let this happen. Americans have become net savers changing directions quickly and reversing a trend that was considered inevitable just twelve months ago. If this trend persists,the global structural imbalance that American profligacy is supposed to have created may be a thing of the past. And wonder of wonders,the US is actually crawling towards the fundamental reform of its bloated health care system. Again,the messy debates and dissents are likely to ensure that any new system does not kill the incentives for medical progress for after all most life-extending and life-enhancing medicines and procedures in the last fifty years have been born in the US.

The best metaphorical analogy for democratic capitalism seems to emerge from the field of biology. Like organisms,which mutate,learn and evolve to more efficient life-forms so does the market in a democratic eco-system. The next level is by no means perfect. There will be new problems and fresh mutations,for the pursuit of perfection in biology is always directional and does not result in arriving at one unique destination. Political economy seems no different. When you have tops-down attempts to fix the problems of an economy,the leaders and their academic backers have a sense of control. But this sense,which in any case is largely illusory,is bought at the expense of risk-taking,experimentation and progress. The latest hot story of American business is not that investment banks have caved in and become commercial banks (that’s day-before-yesterday’s news) but that Google is launching a cloud-based operating system to challenge Microsoft’s desk-based one. Here innovation is at work again and value is being created. Even though personally we might like to take sides,if one of these giants were to go bankrupt,

it would reassure everyone that risk-taking is fine,new wealth can and will replace old wealth and whoever wins all of us will be collectively better off.

So here’s raising a toast to messy,crisis-prone,debate-driven,learning,evolving democratic market capitalism. May our children and their children drink from its waters.

The writer divides his time between Mumbai,Lonavla and Bangalore


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