Social Capitalism/Capitalist Socialism

The Bill Moyers Program had a guest, Emma Coleman Jordan, who made a very interesting point with regard to the experience of the past couple of weeks. We are seeing companies becoming so large that if they fail, their failure could trigger a chain reaction that will cause grave problems for not only the economy of the nation but of the world. Consequently, the government has to step in and save those enterprises if they get in sufficient trouble. The means of saving these companies this time has resulted in even larger companies being formed by mergers and acquisitions of the failing firms by others that are more sound.

This does not sound like the laissez faire capitalism, and indeed the federal government is taking ownership in the companies through warrants and other mechanisms, as well as regulating them to see that they don't fail. It has the authority to force top executives to resign and to force the sale of the firms. The financial capacity of the federal government in form backs these enterprises. At the same time the power of shareholders and their designated managers is weakened.

This does not sound like socializing the enterprises, as many nations have done to many key enterprises in the past. For most of the time and for most purposes the Board of Directors and the corporate managers are responsible for running the firms, the firms are run for profit, and investors share in those profits. Indeed, the firms through the political action of their executives and investors, through political action committees, and through trade associations have considerable influence over the political systems of government.

Perhaps we are seeing a new mixed system with features of both socialism and capitalism being created. Indeed, when five financial institutions have a combined portfolio of four billion dollars, the scale of activity is beyond that of historical capitalist enterprises.

In a previous posting I noted that the regulation of these companies required the use of computer models to assess the risk that they were incurring (and we now discover passing on to the federal government and to the taxpayer). There is a problem with such computer programs. They can fall into error"

• If they are built on theory which proves to be incorrect or inadequate,
• If they are parameterized with data which proves to be incorrect,
• If they are run with data on initial conditions or current conditions which proves to be incorrect or insufficient,
• If they embody assumptions that prove incorrect, or
  
• If they are implemented incorrectly, containing for example programming errors.

These models are so large and complex that they are very hard to understand. Indeed, they may be the product of teams of people over time, such that no one fully understands the model as it is being used.

A part of the current problem is that the federal regulators did not construct independent models which they could run to make independent estimates of the risk in the portfolios of the largest financial firms, but rather depended on the models which the firms themselves operated and used for their decision making. Thus if, as proved to be the case, the firms made bad choices and accepted too much risk, the regulatory agency was unlikely to be able to perceive that risk in advance.

We have yesterday a government investment of nearly a trillion dollars in the financial sector. If the government is on tap to make such investments, albeit if only once a century, in order to try to save the economy from deep recession, then it better have independent means to understand and monitor the risks involved, and means to impose regulations to manage those risks.