Global Economic Collapse and the Original Vision of Adam Smith (Part 1 of 3)

Adam Smith

POSTED September 18, 12:03 PM
Judah Freed - Political Issues Examiner

Adam SmithAs the world catapults into what could be the worse financial crisis since the Great Depression, we're seeing the results of free-market capitalism run amuck. Please observe the irony here. Today's crisis is a direct result of unreasonably deregulating financial markets in the holy name Adam Smith. Yet such policies are contrary to what Adam Smith himself envisioned.

Before we look at Smith in the 18th century, but let's first turn our attention to more recent history.

In response to the Great Depression, President Franklin D. Roosevelt and the U.S. Congress established the Securities and Exchange Commission (SEC) along with related regulatory agencies. Their job was to prevent the kind of wild financial speculation and greedy fraud that led to the Wall Street crash of 1929. The crash wiped out fortunes among the upper class while plunging the middle and lower classes into desperation.



Secured by this regulatory regime, the U.S. economy boomed after World War II. As prosperity grew, a parallel desire for deregulation grew under both Republican and Democratic administrations. This drive peaked in the administration of George W. Bush, who effectively gutted the SEC, the Commerce Department and other watchdog agencies while sinking the nation to debt by borrowing hundreds of billions to fund foreign wars. In a nutshell, the regulators were deprived of the funding and manpower to do their jobs effectively.

The lack of any real government regulation and oversight, consequently, allowed massive lending to millions of unqualified home buyers, which led to the sub-prime U.S. mortgage market collapse.

The reckless lending was based on the false belief that real estate prices would rise forever, that homeowner equity would keep increasing without limit. People with low or erratic incomes were unduly reassured by lenders that they could expect to refinance or sell their homes at a profit before their huge balloon payments were due.

Mounting foreclosures since last year have provided a harsh reality check. The fantasy bubble has popped.

Let's look at basic economics. A foreclosed mortgage is worth only a fraction of its original market value. In communities with numerous foreclosures, the resulting drop in property values means homeowners find themselves owing more than their house is worth on the open market. They are "upside down" in their houses, which induces them to try selling their homes, which further reduces property values. This directly and indirectly leads to more foreclosures.

Companies holding foreclosed mortgages suddenly find themselves holding worthless scraps of paper. Well, actually, we're talking about digital entries in electronic ledgers, but you get the idea. Organizations that invested in securities based on sub-prime loans to high-risk borrowers, naturally, are the hardest hit. The resulting chain-reaction is what led to today economic crisis.

The failure of the sub-prime mortgage market has now spread to all major financial houses in the U.S. and overseas that had any substantial stake in sub-prime investment instruments. The financial failures of overextended lenders, such as Countrywide, have recently led to the government takeover or nationalization of the two largest U.S. lenders and mortgage investors, Fannie Mae and Freddie Mac. The takeover largely was necessary due to lax government supervision of these semi-private institutions.

Despite the U.S. government subsidizing the sale of Bear Stearns to JP Morgan last March and the government bailout this week of American International Group (AIG), we're now seeing the failure or threatened failure of such Wall Street giants as Lehman Brothers, Merrill Lynch, Washington Mutual, Morgan Stanley, and Goldman Sachs. These are merely the top names on a long list.

Because of increasing global interdependence, U.S. banking failures are the catalyst for a wider financial crisis internationally. The uncertainty inherent in this crisis is inducing precipitous stock market drops from a lack of investors confidence, causing otherwise healthy companies to lose their capitalization overnight.

A five percent drop in overall stock values on Wall Street means billions in funding evaporating into thin air. These are funds that could have gone for such things as creating jobs or converting to alternative energy sources. Instead of wealth spreading from the top tier throughout society (the trickled down economic theory), fear and privation now is spreading from top to bottom.

Don't be deceived into thinking these abstract ideas will have no concrete effect on you. Within the next few months and years, what seems like only scary or confusing headlines today will adversely effect you and everyone else on the planet.

And this brings us back to Adam Smith. (Go to Part 2.)