FINANCIAL CRISIS: How Would the Entrepreneur Deal with it?

We are witnessing continuing frenetic government activity all with the goal of reversing the course of the current financial crisis. It seems that if someone can think of something to try, it is tried.

Just think about it:

  • Fanny Mae and Freddie Mac get in trouble so the government pumps in $90 billion and assumes hundreds of billions in potential liabilities.
  • Banks and mortgage companies get in trouble making bad mortgage loans and the government offers $700 billion to solve the problem.
  • Banks get a little short on cash so the government pumps in billions by buying preferred stock.
  • AIG makes stupid mistakes so the government gives it $100 billion to tide it over.
  • The auto companies made poor decisions about the type of cars they offer so the government loans them $25 billion to keep them afloat.
  • Two mortally wounded companies – General Motors and Chrysler – decide they would rather die together than die alone and the government is asked to contribute $10 billion to the burial fund.
  • Banks make thousands of mortgage loans to individuals who did not have the resources to pay them off so one politician proposes $300 billion be allocated to pay the loans and make the banks whole.

We could go on and on, but one thing is clear – if we are simply going to continue to allow bureaucrats to throw money (our money) at the financial crisis – we are going to need a bigger printing press. Bureaucrats abhor accountability and establish elaborate systems to hide from it and protect the status quo. They are the last ones to recognize and implement the real change and resist implementing it. 

On the other hand, if entrepreneurs were running the show, things would be entirely different. We would save hard-earned tax dollars. We would restore financial system credibility. We would clear the financial and congressional communities of the miscreants that foisted this calamity upon us. And we would pave the way for unprecedented capital growth and personal prosperity in the future. 

More about this miracle cure for the financial ails that beset us in a moment. First, some background.

Financial Crisis vs. Recession? What’s the Difference?

There is a huge difference between a financial crisis and a business recession, although a financial crisis can trigger a recession. A financial crisis occurs when the trust and confidence in the flow of capital is lost and the intrinsic integrity of financial instruments and institutions is questioned. A business recession, on the other hand, emerges when the capacity to produce goods and services exceeds the needs of the market.

Keep in mind that a recession is a natural business cycle that periodically occurs in all free market economies. Financial crises are not. They are man-made catastrophes that can and should be prevented.

What few people realize is that a recession invariably leads to a greater public good. It works like a natural forest fire that cleans out the underbrush and weak trees. It cleans the way for future forests. Just as it is now accepted that preventing natural forest fires actually inhibits the growth and health of the forest, it is also a mistake to artificially head off a recession as the bureaucrats are now hard at work doing in a hopeless attempt to delay the inevitability of a recession. A recession is a peerless way the gods of capitalism hold capitalists accountable for their actions. A recession cleans out the weak companies and clears the underbrush of poor decisions and sets the stage for future growth.

In the past, most recessions were the result of business cycles not financial system failure. Prior to the current meltdown, the only real exception to this occurred in 1929 when America was poised to enter a recession due to the excesses of the “roaring 20s.” The depression was actually triggered by a bank liquidity crisis that drove the recession into a decade of depression.

In a way, the current crisis is a replay of 1929. It is generally accepted that excesses in the housing market drove America down the path to the first real recession since the early 1980s. The emergence of the financial crisis simply accelerated the onset of recession and probably exacerbated the depth and length of the downturn.

History’s Great Lessons

Usually, the reaction of government in a business recession has been to let it run its course while implementing social programs, i.e. extended unemployment benefits, social relief and public works in order to protect individuals from unfairly suffering during the economic downturn. During the depression the Roosevelt administration did step in to shore up the financial system and implement new regulations to prevent recurrence, but except for pubic works and social programs designed to help individuals, Roosevelt did not interfere with the natural course of the depression. Government allowed the economic system to hold weak companies accountable for their actions.

It was painful, but here’s the good news: the economy emerged from the depression with stronger companies and greater opportunities for new, creative, nimble and entrepreneurial companies. This set the stage for almost 50 years of virtually unabated economic expansion and economic vitality. (Of note is that this expansion “spread the wealth” in American to broader and deeper levels than had ever been experienced.) Even though Roosevelt is vilified to this day by those who felt he was (at best) an anti-capitalist socialist, it seems he understood the natural ebb and flow of true free market capitalism. Certainly he understood the dynamics of capitalism which includes accountability as well as reward much better than do today’s political leaders.

Now however, the government bureaucrats as well as bureaucratic business leaders are attempting to throw the natural balance of free market capitalism out of whack by eliminating a fundamental crucible of the entrepreneurial system and that is the fear of accountability. Fear of failure and accountability is the great regulator of incompetency, bad decisions and the ignorance of risk. When there is no fear then greed and stupidity prevail.

The bureaucrats have approached the current financial crisis and recession with a philosophy that “failure” is unacceptable and must be eliminated. It is faulty logic to believe that if “failure” is taken out of the equation then the financial crisis will be solved and the recession prevented. All the efforts taken so far and proposed have the objective of preventing the failure of banks, mortgage companies, insurance companies, auto companies and those who took home loans they could not afford. Just this past week, it was even proposed that banks forgive the debt of those who are behind in their credit card payments. Who knows how many more companies and individuals will get in line to be absolved of accountability for their actions? If companies and individuals come to believe that they will not be held accountable for their actions and that the government will bail them out if bad decisions are made then chaos and decline will surely follow.

These actions have the effect of exchanging accountability for dependency and that creates a natural breeding ground for bureaucracy. If these actions continue they will destroy the free market economic system by taking decisions out of the hands of the true entrepreneur and putting them in the power of the bureaucrat.

This leads us to the natural question: What would the entrepreneur do?

Restore Integrity of the Financial System

First, the entrepreneur would acknowledge and demand a stable, reliable system. They would accept that it is government’s responsibility to assure financial stability. However, the entrepreneur would make the distinction that it is the government’s place to regulate the financial and business systems, but not run them.

Enhance Governmental Regulation

Many might be surprised to discover that the entrepreneur would favor increased regulation, but that would be the case so long as regulation was designed to create a level playing field and not actually be on the field playing. The entrepreneur recognizes that a level playing field allows everyone an equal opportunity to participate, win or lose.

Regulation that seeks to substitute the decisions of the consumer and the entrepreneur for those of the government inhibits creativity, innovation and growth. Regulation that is too lax (or non-existent) opens the door to unfair competition, uncertainty and chaos. The entrepreneur welcomes regulation that creates a level playing field by requiring transparency, consumer protection and consistent rules that can be relied on to be enforced.

For example, the seeds for today’s financial crisis were sown with the repeal of regulations for banks, investment firms and insurance companies put in force during the depression of the Progressive Era of the 1930s. By removing these regulations, the playing field became uneven and confused. Unfettered by regulation and allowed to run their businesses according to Adam Smith’s “invisible hand” of enlightened self-interest, banks, investment firms and insurance companies became free to act in areas where they had little experience—without transparency, consumer protection or accountability. Even former Fed Reserve Chairman Alan Greenspan confessed that this new freedom took the laissez-faire philosophy to ill-considered lengths.

  • If banks had known they would be held accountable for making bad loans, they would have been more reticent to make them.
  • If insurance firms felt they would be held accountable for taking risks that could not be properly managed they would have been less likely to do so.
  • If investment firms felt they would be held accountable for selling securities that lacked transparency or for leveraging their assets beyond reason, they would have resisted the urge to do so.

The entrepreneur would support the bailout efforts for the financial system because without a reliable, effective and efficient flow of capital there is no opportunity for the entrepreneur to function. However, this support would come with a demand that those who created the potential for the crisis by repealing regulation be held accountable and that new regulations be put in place to create a new level playing field.

Foster Entrepreneurial Creativity

Lastly, when it comes to the declining economic conditions in America, the entrepreneur would recognize that one of the reasons for the current recession is the result of a changing environment. The entrepreneur would recognize that the nature of economic opportunity is changing, but unlike a bureaucrat, the entrepreneur would view this as an opportunity, not a threat to be resisted.

Take the auto industry as an example. Everyone understands that the auto industry, based on the internal combustion engine, is in the sunset of its existence. There is no future for the auto as we know it. However, fearful of the pain and challenge of change, the bureaucrat throws good money after bad to maintain the status quo and attempt to forestall the inevitable. Certainly the failure of the American auto companies would dramatically impact the economy by eliminating hundreds of thousands of jobs, but in the long run artificially keeping these jobs in existence will only make the ultimate price and pain greater.

The entrepreneur, rather than throwing hundreds of billions of dollars away trying to preserve what can’t be preserved, would allow the industry to die a natural death and encourage the government to invest those funds in creating a new concept of the transportation industry. Instead of tinkering with electric cars and dreaming of hydrogen propulsion investment capital should be made available as incentive for entrepreneurs to discover a solution.

This is Not a New Concept

There has always been an unstated partnership between the bureaucrats of government and the entrepreneurs of the free market. The bureaucrats know that critical to retaining their power is a stable financial system and a growing economic base. The entrepreneur knows that to be successful there must be a level playing field of opportunity, the incentive of reward and reliable access to investment capital.

In the 1840s, when the US government wanted to develop a more efficient national transportation system it did not pour more money into stagecoaches and wagons, but offered free land as an incentive for entrepreneurs to build a national railroad system. This hurt the stagecoach companies and their employees, but the railroads created the environment for strong economic growth that created thousands of new jobs. When the potential for airline travel was recognized, the government provided incentive to entrepreneurs to develop the system by offering highly profitable contracts to carry the mail. This, in effect, subsidized a new industry until it could stand on its own. (I won’t go into the current airline problems here.)

A modern parallel for the continuing partnership between the bureaucrats of government and the entrepreneur is in energy. Sure, oil companies are making billions of dollars in profit now, but they are merely like celestial supernovas that burns brightest just before they die. As domestic oil is depleted and foreign sources become more unreliable, the bureaucrat says, “Drill baby drill.” The entrepreneur understands your don’t solve tomorrows problems with yesterday’s solution. This is a classic “fiddle while Rome burns” scenario. Instead of annually spending $700 billion of national wealth on a dying system, the entrepreneur would allocate serious investment in alternative energy. Provide the support and incentives for the entrepreneur to find the solution and they will. With the proper government support and incentive, the entrepreneur will develop new industries creating millions of new jobs and stimulating another extended period of real growth.

Basically what the entrepreneur would propose is a new infrastructure for the American economy. Of course, such a dramatic structural change in the nature of the American economy will be painful for many, but the ultimate benefit for everyone will far outweigh the pain. As in the past, whenever such a structural change has taken place, for every job eliminated from a dying industry five new ones were created by the entrepreneurs building the new industry. The bureaucrat never wants pain, not understanding as the entrepreneur does that without pain their can be no gain.

So what is the moral of the story? What is the difference between how the bureaucrat and the entrepreneur would deal with the current financial crisis? It’s simple: The bureaucrat spends attempting to preserve the old and the entrepreneur invests in order to build the future.

 

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