Wall Street always leads the world economy. The smart people sitting behind all electronic boards were worshiped like god. Through them, financial institutions have extended their tentacles in almost every industry, every nation on every continent. It seems no one else understands better than they do about economy. And this time, they are leading us again, on a roller-coaster. The free-fall after each ascend, where one’s heart frantically holds itself against one’s back, that is the part we are riding now.
Breaking news is falling like snowflakes. Big names, one after another, were shivering. None escaped the storm. How did it happen? At the beginning of 2007, mortgage market started declining. April 2 2007, New Century Financial, largest U.S. subprime lender, filed for bankruptcy. In another half year’s time, 4-5 other prominent mortgage lenders had filed bankruptcy. Before we could fully digest what had happened to the market, the panic quickly spread to financial institutions, globally. August 29 2007, Australian Hedge Fund applied for bankruptcy protection. After 15 days, British bank Northern Rock reported severe liquidity problem. Then a race of loss reporting started. In the following 6 months, more than half a trillion dollars had evaporated from bank’s assets. Few lucky ones like Bear Stern, Merrill Lynch were merged; the others like Lehman Brothers had to shut its door after one and a half century of business. Macro-economy is reacting swiftly to the turmoil. U.S. reached 11% unemployment (well, that Palin spent $ 150,000 in October is a story of another day); Iceland defaulted on its foreign debt; Hungary and Pakistan are on the row; China has suffered a 3rd consecutive quarters slowing growth rate. Couple of weeks back, Nikki index in Japan made 12% loss in a single day, which is the lowest level since 20 years.
Central banks had joined hands in an unprecedented collaboration to ward off the crisis. Then bold, and bolder rescue plans were announced; astronomical figures dominated headlines: $700 billion in the US, $ 205 billion in Sweden, $ 750 billion in Germany, $ 103 billion in South Korea… Tens of trillions of dollars have been poured into the market to ease the credit crunch. Central bank lending rates have been cut to historical lows. Financial minister in Japan had wished to give interest to borrowers to encourage lending.
Those smart people did not save us. Nor anyone ever could. They merely stared unbelievably at the falling index, with wide open jaws: no one has completely understood the market. Recession has become the most quoted word on news. What triggered by the subprime crisis has reached far beyond anyone’s wildest imagination. Despite all the joint high dose injection, the patient still shows no sign of recovery.
Where did all the money go? What went wrong? Alan Greenspan, the once legendary chairman of Federal Reserve, was summoned before U.S. Congress. He admitted that his assumption that each player in the market would take necessary measurement to protect themselves was wrong. In other words, the free market concept failed. The invisible hand promoted by Adam Smith 100 years ago failed to function. Critics reacted relentlessly to blame everything on free market concept.
Although the free market concept had been the corner stone of modern capitalism and served us gloriously in the past decades, it is wrong now. In simple words, free market theory refrains government interference in the market. Each market player is expected to ensure the best interest to itself: highest profit & lowest risk. The regulators merely enforce the free flow of information, market integrity and property right. Fundamental property right will be protected, then players left to choose what is best for them. Does it sound familiar with the structure of democracy? In democracy, people are protected with all property rights: life, earning, privacy, house et al. Then people are free to choose the best for themselves. However, law can only protect people from external harms. But law cannot protect people from harming themselves. Not all democracies have succeeded. Actually, it is quite disastrous in many places. Does it mean democracy is wrong? In the free market, regulations require banks to obtain adequate information from the prospective borrowers before granting the loan. But those precautions were abandoned. Everyone was abandoning them. Law or regulation cannot enforce the functioning of market, which largely depends on the people who are practicing it. The current turmoil is rather the fault of operators than the fault of the market mechanism. Thousands of years now, we have not escaped the temptation of greed. We still tend to blame everything else except – us. You may dispute what I have argued here. But we are all witnessing a soon to be well cited example in the text books and academic research.