'Too big to fail' distorts capitalism

Columbia University Economics Professor Joseph Stiglitz does not obfuscate, not when it comes to free markets, the global financial crisis, or American capitalism.

Stiglitz said Friday on PBS's "Charlie Rose Show" that American capitalism contains a non-conforming component that policy makers need to address. Stiglitz said capitalism, and in particular American capitalism (corporate capitalism) requires both the potential for reward and the possibility of risk or failure. However, in the United States we have the doctrine of 'too big to fail' (or too interconnected to fail) which essentially means any bank, institution or entity whose failure would pose systemic risk, will be maintained or taken over by the United States government. But this doctrine blots-out the risk component of the risk / return in capitalism, he said. "This is not capitalism," Stiglitz said.

Interventions that are hard to define

Indeed it isn't, as my DailyFinance colleague Peter Cohan and others have pointed out on many occasions. Some have called the government's interventions in Citigroup (C), Bank of America (BAC), AIG (AIG) et al. socialism, but strictly speaking the interventions are not socialism, as the benefits from these interventions will not flow entirely to society; private shareholders will likely benefit in some way from the interventions. Further, the interventions will not result in the nationalization of the means of production, the U.S. economy will remain largely private sector-based, and there will be no power base to displace corporate executives as the primary decision makers in commerce. So socialism, the interventions ain't, either.

However, the interventions don't fit neatly into the category of state corporate capitalism (ala energy, defense, transportation, pharmaceutical, communications sectors) either because under that policy companies (such as airlines) have been allowed to fail.

One can't even describe 'too big to fail' as what investor Jim Rogers termed 'socialism for the rich'. If federal support of Citigroup means that Citigroup will maintain X amount of bank branches in poorer neighborhoods, such as in New York's Harlem and on the South Side of Chicago, and lower-income residents use these services, one can hardly say the intervention only subsidizes the rich.

Stiglitz leaves the exact category placement of 'too big to fail' to others, preferring instead to concentrate on one characteristic: it isn't capitalism, because the policy has removed risk from the arena, and if we want capitalism we either have to: 1) break up these institutions so that they're no longer too big to fail or 2) end the 'too big to fail' doctrine.

Economic Analysis: Economist Stiglitz is not calling for a sudden end to 'too big too fail,' but his recommendation obviously poses very large economic policy questions for United States.

My view? First, we're in unchartered waters here, so public policy in this area is going to take years to formulate, hence this policy outline is subject to revisions. Second, ignore the 'limited government' / original intent / market absolutists: it's difficult to see how such strictures could lead to effective policy today, although backers of the above may end up contributing a constructive tenet or two. Third, all policies must respect the U.S. Bill of Rights, the rule of law, the separation of powers, with the Congress as the primary composer of the new policy. Fourth, being a mercantilist who views the economic arena as a competition among nations, not corporations, the bias would be toward protecting companies / sectors that maintain or enhance the strength of the United States vis-à-vis other economic powers, most especially those policies that support a national industrial policy. In other words, if by federal support of Bank XYZ in Silicon Valley, California's tech sector retains an ample source of capital for research and development, and expansion, then the federal government should maintain Bank XYZ.

Financial Editor Joseph Lazzaro is based in New York.

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