| -- | May 1, 2018 Capitalism Can’t Work Without Losers By Patrick Watson Those who support free-market economics say it is the best, most efficient path to maximum prosperity for everyone. In other words, everybody wins in a free market—not equally, but each person at least has the opportunity for a prosperous life. I agree with all that, except the “everybody wins” part. In fact, free markets don’t work well at all unless certain people lose. Otherwise the entire system fails and everyone loses. Which is happening right now. 
Photo: Getty Images Forgetting the Lessons Neel Kashkari, president of the Minneapolis Federal Reserve Bank, is often in the news because he dissents from the Fed’s rate-hike decisions. He previously worked at Goldman Sachs and PIMCO and was assistant Treasury secretary overseeing the crisis-era Troubled Asset Relief Program (TARP). After running one of the top bailout programs, Kashkari now thinks the “too big to fail” banks are, well, too big and should be broken up. I imagine that makes for some interesting conversations with the banks in his district. Kashkari went on a little rant at a Howard University event last month. Here are some quotes my Twitter pal Pedro da Costa reported for Business Insider. - “We are forgetting the lessons of the 2008 crisis.”
- “The shareholders got bailed out. The boards of directors got bailed out. Management got bailed out. So from their perspective, there was no crisis.”
- “No other industry is levered like the banking industry. If we double the amount of equity banks have, we could go a long way toward resolving the problem that too-big-to-fail banks pose.”
- “If it were up to me, we’d be increasing banks’ leverage ratio, not decreasing it.”
Those last two comments are important. Banks profit mainly by lending money that was itself loaned to the bank by depositors and bondholders. This gives them leverage, which makes them vulnerable to losses when borrowers default. As a result, there’s a constant tension. Bankers want more leverage so profits will be higher. Regulators want to allow less leverage so the banks are less likely to fail. They meet somewhere in the middle. The Fed manages this balance and does a pretty good job of it... until something like 2008 happens. But here’s the problem: Our bank-stability apparatus—the Fed, the FDIC, occasional bailouts—encourages banks and other lenders to take unwise risks because they know (or at least believe) they’ll get rescued. And that brings us back to free markets and losers. 
Photo: Getty Images Hiding the Message We heard a lot in the crisis, and still now, about people taking out loans they couldn’t afford. Obviously, that’s a bad idea. But every loan has two sides: borrower and lender. Both have responsibilities. Just as borrowers shouldn’t overstretch, lenders shouldn’t over-lend. That’s partly how we get crises like 2008. In theory, the free market imposes discipline on both sides. It certainly does for borrowers. Default on your mortgage and every future lender will either deny you credit or charge you much higher rates… and rightly so. But on the lender side, responsibility for mistakes stays hidden. As Kashkari said, bank executives and directors who made bad decisions leading up to 2008 felt little punishment. So, the system tacitly promotes irresponsible lending. The free-market way to prevent this is for irresponsible lenders to lose all their money. It would send other lenders a message: “Avoid doing what they did.” Government bailouts keep that information from the people who need it. The result: an unstable banking system that builds up unsustainable debt and periodically implodes. 
Photo: Getty Images Raising Taxes This isn’t just a US problem. An April 18 Financial Times story reported on some African countries slipping into a debt crisis. Here’s an excerpt: With the number of countries already unable to service their debts doubling in the past year to eight, officials at the International Monetary Fund are urging all African countries to raise taxes to provide more scope for paying interest, which has increased to levels last experienced at the start of the century. While we don’t know the details of these troubled loans, we can infer a few things. First, it’s not new information that some African governments are unstable, corrupt, and have trouble servicing their debts. That has been the case for decades. Second, anyone who lends money to those governments should know those risks and price their loans accordingly. These lenders apparently didn’t. Whose fault is that? Not the borrowers’, and certainly not the citizens’ who the IMF now insists pay higher taxes so the lenders get their interest. What should happen here is… - Those lenders lose their money.
That would teach other lenders to require sustainable, realistic loan terms and interest rates. It would be short-term harder on the borrowers, but in the long run help free them from perpetual debt serfdom. Don’t Blame Capitalism Similar things happen in the US every day. I don’t think another banking crisis is imminent, but we’ll have one eventually. When that crisis comes, some people will want to blame capitalism—but the real culprit will be the lenders’ lack of market discipline. We could avoid this, or at least make it less painful, by taking the kind of steps Neel Kashkari recommends. But don’t hold your breath. Before I go, a quick reminder: On Monday, you may have received an email from John Mauldin describing some important changes at Mauldin Economics. Please open and read it as soon as possible. It describes a time-limited action you might want to take. Since the email went only to select readers, that’s all I can say publicly for now… but I’ll tell everyone more in next Tuesday’s Connecting the Dots. I think you’ll like it. See you at the top,  Patrick Watson P.S. If you’re reading this because someone shared it with you, click here to get your own free Connecting the Dots subscription. You can also follow me on Twitter: @PatrickW.  | Subscribe to Connecting the Dots—and Get a Glimpse of the Future
We live in an era of rapid change… and only those who see and understand the shifting market, economic, and political trends can make wise investment decisions. Macroeconomic forecaster Patrick Watson spots the trends and spells what they mean every week in the free e-letter, Connecting the Dots. Subscribe now for his seasoned insight into the surprising forces driving global markets. |
 Senior Economic Analyst Patrick Watson is a master in connecting the dots and finding out where budding trends are leading. Patrick is the editor of Mauldin Economics’ high-yield income letter, Yield Shark, and co-editor of the premium alert service, Macro Growth & Income Alert. You can also follow him on Twitter (@PatrickW) to see his commentary on current events.
Share Your Thoughts on This Article
Use of this content, the Mauldin Economics website, and related sites and applications is provided under the Mauldin Economics Terms & Conditions of Use. Unauthorized Disclosure Prohibited The information provided in this publication is private, privileged, and confidential information, licensed for your sole individual use as a subscriber. Mauldin Economics reserves all rights to the content of this publication and related materials. Forwarding, copying, disseminating, or distributing this report in whole or in part, including substantial quotation of any portion the publication or any release of specific investment recommendations, is strictly prohibited.
Participation in such activity is grounds for immediate termination of all subscriptions of registered subscribers deemed to be involved at Mauldin Economics’ sole discretion, may violate the copyright laws of the United States, and may subject the violator to legal prosecution. Mauldin Economics reserves the right to monitor the use of this publication without disclosure by any electronic means it deems necessary and may change those means without notice at any time. If you have received this publication and are not the intended subscriber, please contact service@mauldineconomics.com. Disclaimers The Mauldin Economics website, Yield Shark, Thoughts from the Frontline, Patrick Cox’s Tech Digest, Outside the Box, Over My Shoulder, World Money Analyst, Street Freak, ETF 20/20, Just One Trade, Transformational Technology Alert, Rational Bear, The 10th Man, Connecting the Dots, This Week in Geopolitics, Stray Reflections, and Conversations are published by Mauldin Economics, LLC. Information contained in such publications is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. The information contained in such publications is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed in such publications are those of the publisher and are subject to change without notice. The information in such publications may become outdated and there is no obligation to update any such information. You are advised to discuss with your financial advisers your investment options and whether any investment is suitable for your specific needs prior to making any investments.
John Mauldin, Mauldin Economics, LLC and other entities in which he has an interest, employees, officers, family, and associates may from time to time have positions in the securities or commodities covered in these publications or web site. Corporate policies are in effect that attempt to avoid potential conflicts of interest and resolve conflicts of interest that do arise in a timely fashion.
Mauldin Economics, LLC reserves the right to cancel any subscription at any time, and if it does so it will promptly refund to the subscriber the amount of the subscription payment previously received relating to the remaining subscription period. Cancellation of a subscription may result from any unauthorized use or reproduction or rebroadcast of any Mauldin Economics publication or website, any infringement or misappropriation of Mauldin Economics, LLC’s proprietary rights, or any other reason determined in the sole discretion of Mauldin Economics, LLC. Affiliate Notice Mauldin Economics has affiliate agreements in place that may include fee sharing. If you have a website or newsletter and would like to be considered for inclusion in the Mauldin Economics affiliate program, please go to http://affiliates.ggcpublishing.com/. Likewise, from time to time Mauldin Economics may engage in affiliate programs offered by other companies, though corporate policy firmly dictates that such agreements will have no influence on any product or service recommendations, nor alter the pricing that would otherwise be available in absence of such an agreement. As always, it is important that you do your own due diligence before transacting any business with any firm, for any product or service. © Copyright 2018 Mauldin Economics | -- |
