Tuesday, October 28, 2008

Rescuing Capitalism

It would be fairly easy to dismiss the gleeful boast by President Nicolas Sarkozy of France that American-style capitalism is over, to file it with French critiques of fast food and American pop culture.

Except that the United States government now owns stakes in the nation’s biggest banks. It controls one of the biggest insurance companies in the world. It guarantees more than half the mortgages in the country. Finance — the lifeblood of capitalism — has to a substantial degree been taken over by the state.

Even Alan Greenspan, the high priest of unfettered capitalism and a former chairman of the Federal Reserve, conceded this week that he had “found a flaw” in his bedrock belief of “40 years or more” that markets would regulate themselves. “I made a mistake,” he said.

The question is what new direction capitalism should take. In a globally interconnected world, the United States cannot simply march back to the gray flannel capitalism of the 1950s and 1960s when regulations were tough and coddled monopolies dominated the corporate world. Still, the next president will have a chance, not to be missed, to re-evaluate some tenets of the freewheeling, deregulated version of a market economy that has dominated America since the Reagan administration.

Financial deregulation enabled our boom-and-bust dynamic — removing barriers to capital flows, allowing unrestricted trading of abstruse financial products and letting financial institutions take on more and more debt. Cheap money, from China or the Federal Reserve, fueled the fire. But America’s virtually unregulated shadow financial institutions — brokerages, hedge funds and other nonbank banks — played a particularly important role at the center of this process.

The solution will require rethinking the rules of finance. The amount of capital that banks must keep in reserve will have to rise; deregulated financial institutions will have to be regulated. Yet much more will be needed than just putting the bridle back on American banks.

The next government must re-establish some notion of equity of opportunity. Investment is desperately needed in health care, education, infrastructure. The social contract and the government’s role in it should be examined anew. Addressing these challenges will be an enormous task — especially amid the bitter recession that most economists expect over the next year or so. But they must be faced. Fixing finance is merely the start.

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