09 December 2008

Beyond Capitalism: The Implosion of Financial Markets and Rise of Financial Regulation

Within the United States and abroad the worst economic slowdown in 70 years of history is playing out; the depths of this depression have yet to be reached. As policy makers strive to slow and end this contraction with a later eye on rebuilding, we are seeing a discussion centered on governments role in promoting the health of an economy and the security of the workforce. In the short to medium term, we will see backs turned on the deregulation and cavalier economic policies of the nineties and much of the recent decade, as more regulation and social services are implemented. This "beyond capitalism" approach will then begin to come under increasing scrutiny once the economy begins to takeoff and we once again ask how much regulation is best for the long haul. We may or may not see beyond capitalism for the longterm.

The implosion of financial markets largely came about as a result of the increasingly complex financial instruments which were being traded in recent years. As futures and options began tangling with shorting, highly leveraged purchases, hedge funds, and valuations of esoteric commodities, securities, weather events, and more, it became impossible for even the most discerning analyst to put a dollar value on such derivatives. As the housing market contracted and subprime defaults increased, liquidity began drying up. In the last few month we have seen this crisis spread to virtually all areas of both the domestic and global economy.

The basic cause of the initial housing-downturn was overvaluation of mortgage based derivatives. Although economic theory is premised on the assumption that agents behave rationally and have equal access to information this is of course not true; and that is why the market failed. Historically, this information asymetry has not had such global consequences because markets were not significantly integrated. The current crisis results from a combination of globalization and chance.

Beyond Capitalism will pay heed to the market imperfections and will take steps to mitigate the risks associated with lack of information and imperfect information. The market fixes will consist of government regulation which will act to correct the playing field. Mechanism Design is such a developing field. MD is concerned with game theory and designing rules that take economic realities into account as efficiency is sought. (The 2007 Nobel Prize in Economics was awarded to three economist who laid the foundation to this field.) In addition to changing the rules, the U.S. will also become more socialized and nationalized as the effects of the slowdown are mitigated via propping up of private sector businesses and implementation of government spending programs aimed at both job creation and social services for the newly needy.


Dewey Nohow said...

Beyond Capitalism - This is a topic that deserves our attention. What do we want to retain and what do we want to change. What values do we want to encourage. What goals do we seek. For some of us, our current goals and aspirations seem one dimensional and boring. For us, we welcome change. I welcome the search for new models and operation systems. I have no answers, but collectively we can turn these challenges into opportunities (pardon the cliche).

Dewey Nohow

S. Pell Checker said...

You have a mispelling in your title!

Anonymous said...

do you know what a goomba is?