Banker calls for a "new capitalism"

Today there is an interview on National Public Radio with British banker Stephen Green, chairman of giant international money center bank HSBC.

In it, Mr. Green puts forth numerous assertions with which we would disagree as proponents of free-enterprise, including the idea that "markets are not reliably self-policing and you do need a government-supported regulatory environment which is constructive and effective in watching out for the weaknesses that are sometimes endemic to the system" and that the recent crisis grew out of global savings and trade imbalances.

We've addressed these topics before (see here and here for instance), but the assertion we want to focus in on is the assertion that corporations have responsibilities to "the community" beyond a responsibility to make a profit -- often called a "social responsibility."

The great Milt Friedman decisively demonstrated the fallacy of this innocuous-sounding idea in his famous 1970 essay "The social responsibility of business is to increase its profits," as we discuss in this previous post.

Some might argue, however, that banking as a business is different -- perhaps banks have social responsibilities beyond other corporations, because society has an interest in more people getting loans for homes or businesses or education, and because banking meltdowns have an impact on all other businesses.

However, we would argue that trying to force "social responsibilities" onto banks contributed greatly to the meltdown. Legislation such as the Community Reinvestment Act dictated that banks lend money based on criteria other than the ability of borrowers to repay. An even bigger example, of course, was the existence of the quasi-government entities Fannie Mae and Freddie Mac, which were also created as a way to further socially desirable goals for home lending.

In this noteworthy video interview between businessman Steve Forbes and economist Brian Wesbury, Mr. Forbes brings up the important insight that the existence of these socialized institutions (Fannie and Freddie, which had the implicit backing of the U.S. government and hence could borrow money at lower rates than a strictly private institution could) drove the private banks into the subprime markets.

As Mr. Wesbury says in agreement with Mr. Forbes' question, "The bigger Fannie and Freddie got, the banks could not compete. Because Fannie and Freddie have the implicit guarantee of the government, which means they can borrow cheaper than banks could in the open market. Therefore they could offer products at lower yields and still make a spread that was wider than banks. The banks had to go into the subprime arena to compete. That was the only place left for them, in a sense. Because Fannie and Freddie had taken out the profit margins in the conventional mortgage market. It just didn't exist."

In other words, contrary to the assertions of Mr. Green (which fit into the misguided economic ideas that NPR frequently promotes), the financial panic's lesson is not that we need a "new capitalism" in which corporations make decisions based on a "wider public interest," but that such ideas (as Milt Friedman told us forty years ago) end up hurting everybody, including the wider public.

* The principals of Taylor Frigon Capital Management do not own securities issued by HSBC (HBC).

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