Is this the end of capitalism? No, this is how capitalism works. But we must get smarter at lending to poor peopleby Mark Hannam / November 23, 2008 / Leave a comment
Writing in 1942, Joseph Schumpeter observed that it was in the nature of capitalism to make progress by means of “creative destruction.” There has been much destruction in the financial sector over the past year: of asset prices, of banks and of confidence. It is not yet widely recognised that this has been part of a creative process, but there is good reason to think that it is.
Asset prices were overvalued, banks were poorly managed and confidence turned out to be complacency in disguise. The time was ripe for a Schumpeterian mutation.
Those who were uncomfortable with the success of the financial services industry during its good years are now—predictably—celebrating its demise. They say that the events of the past year have shown what they knew to be true all along: that financial markets need to be more regulated and subjected to greater political control.
But the fact that substantial government action has been required to mitigate the economic consequences of the current financial upheaval does not prove that financial markets should be more heavily regulated, nor that capitalism has failed. Systemic problems have arisen in the financial markets despite the fact that most participants have behaved responsibly.
The problems we see today are not just signs of failure; they are also signs of progress. If capitalism were better understood—as an economic system that makes progress both through innovation and failure—it might be recognised that government action in times of crisis is needed only to ensure that the process of creative destruction starts again sooner rather than later.
The most interesting question that arises from the current mutations is not, “who is to blame?” but “what can we learn?” The answer takes us to the matter of sub-prime lending—that is, the provision of credit to those who are normally excluded from the financial mainstream.
The proximate cause of our present financial problems is the fact that large amounts of money were lent to poor people in America who only had a realistic chance of making repayment if the value of their homes, against which the loans were collateralised, continued to rise indefinitely. What should we learn from this? The quick answers—depending upon one’s political prejudices—are these: either blame the poor for having aspirations beyond their status and the successive US governments who encouraged wider home ownership, especially amongst minority communities; or blame the banks and mortgage brokers who…