The Role of Risk in Free Markets

As we move even closer to the big election, I continue to hear people voicing opinions, often in angst, about how big business and big banks are evil.  Many point to the idea that capitalism is evil because it is a system that takes advantage of people and operates on greed.  I find these notions absolutely astonishing, but at the same time, I can understand how people could arrive at these conclusions.

Capitalism is a system that is fueled by what some may call "greed."  While I prefer to call this motivating force "self interest," the money or satisfaction attained from pursuing self interest is simply a measurement of earned success.  The word greed implies taking something that does not belong to you, but the free market operates on a system of voluntary transactions.  Those who prosper by providing goods and services must do so by satisfying the needs and wants of their customers.  However, some people fail to realize that innovators put themselves in jeopardy by trying to provide new goods and services to their consumer base.  This is where risk comes into play.

When an entrepreneur wants to develop a new product or service, they must take on risk by underconsuming and saving in order to invest in the development a new product.  They temporarily take on risk with the hopes that their new product will be successful, or they face a failed investment and the consequences that come along with that.  If they do succeed, they get the benefit of profiting from their business venture and these profits symbolize a measure of earned success.  The system works quite well, but the United States has seen great decline in true capitalism.

Unfortunately, the federal government and Federal Reserve are undercutting the risk that businesses are supposed to take on.  Keeping interest rates for investment banks at 0%, subsidizing risky companies, and bailing out failed companies makes it much easier for entrepreneurs to attempt business interactions that would be far too risky in a free market.  Since the Federal Reserve is continuing to give out money at 0% interest rates, it allows big banks to keep loan rates fairly low.  This sounds like a great thing, but in actuality it is a form of price fixing.  Sometimes the market needs to raise rates to encourage saving instead of rampant spending.  If money is too easy to attain, it is less risky to invest.

We have seen just recently that the federal government thinks it knows what companies should have the burden of risk removed, but they have once again illustrated that government intervention rarely works.  In the case of A123 Systems Inc., the $249.1 million dollars granted by the Obama administration was not enough to prevent this company from filing for bankruptcy.  Although instead of A123 Systems dealing with the consequences of a failed investment, it is the American tax payer that bears the burden.  Government subsidies prevent companies from restructuring into efficient business models.

We also see very low risk in the banking sector, which make consumer's decisions about who will hold their money far too easy.  When the FDIC is ready to refund you if your bank goes under, you do not really care if they are making bad investments with the leverage they get from your deposits.  This leads consumers to make uninformed decisions about what banks they should be using.  The Federal Reserve and federal government also played an obvious role in reducing the risk of investment banks when they decided to bail them out after the banks took on too much risk and their investments failed.  By bailing them out, the government essentially erased the consequences of their malinvestment, which will likely lead to further moral hazard in the future. 

By listening to people attack capitalism, it becomes clear that they do not really seem to understand it.  Many of the problems that people attribute to capitalism actually arise due to government intervention in the system.  There are countless more examples of how government intervention in free markets negatively impacts the American people, but these problems are near the top of the list.

-Bob

The Supreme Court Decision and What it Means

 Hi All,

As I'm sure anyone who reads this will know, the Supreme Court of the United States ruled that the individual mandate portion of the Affordable Care Act (aka ObamaCare) is Constitutional.  To my surprise, the Supreme Court did not decide upon its Constitutionality with respect to the Commerce Clause.  In my opinion, this brings both good and bad news to the table.

The good news is that the Court effectively said that, no, Congress cannot exercise unlimited power under the Commerce Clause loophole.  Unfortunately, the Court has effectively granted Congress significantly more power under the tax code!  The Court uncovered a way to uphold the legislation by saying that the penalty to be issued to those who do not buy insurance is a tax.  The Supreme Court argues that the law is Constitutional as a tax because the tax code allows taxes that discourage certain behaviors.  For instance, there are high taxes on cigarettes and alcohol which aid in discouraging people from purchasing these products.  I highly disagree with this argument because those taxes do not really discourage people from buying those products.  These "sin" taxes take advantage of goods with inelastic demand and use them to raise revenue for the federal government.  If these taxes were to truly discourage people from purchasing these products, then the government would simply raise the tax to the point at which no one was willing to purchase them.

The scary part about this situation is that the Court has said that the government cannot force you to buy health insurance, but they can tax you if you don't.  This is a distinction without a difference.  If the government has the power to tax you to coerce your behavior, then they can simply raise the tax to a point that would force you to buy insurance (in this case).  Essentially Congress is being allowed to do through the tax code what it is unable to settle with Constitutional legislation.  If you apply this logic to a different scenario, the implications could be quite serious.  For example, say that after failing to pass legislation that would ban all citizens from purchasing guns due to unconstitutionality, the federal government simply devises a new tax that is so high that it makes it impossible for anyone to purchase a gun.  This could allow the federal government to deny you fundamental Constitutional rights.

The comical part about this case was that the Supreme Court acknowledged the possibility that the Congress could coerce behavior through taxes but still provided that it is Constitutional because the penalty for not purchasing insurance is too low and insignificant.  Since it would be far cheaper to simply pay the penalty (tax), they are in effect saying that this legislation is Constitutional because it will be ineffective.  The Supreme Court also justified the legislation because there is no way to enforce the penalty (tax) on the people.  The Affordable Care Act clearly states that the IRS does not have jurisdiction over this tax, so there is no way to collect it from those not willing to pay it.

Due to this fact and the other provisions in the ACA legislation, it is very likely that many people will not buy insurance until they get sick since they will not be denied for pre-existing conditions.  By having a only people that are sick paying insurance premiums, it will be an excellent way to fast track a total collapse of the healthcare system. 

A major problem with this decision is that even as a tax, the bill should still be unconstitutional.  The federal government does not have unlimited tax power.  There are two types of taxes, indirect taxes and direct taxes.  An indirect tax might come from something like alcohol or cigarettes where the tax is built into the price of a product.  A direct tax is a tax where you essentially send money directly to the government.  Here's the catch though, a direct tax must also be apportioned!  The only direct tax that is not apportioned is the income tax and that was only deemed Constitutional after the passing of the 16th Amendment - which only applies to income.  If the government is imposing a tax that applies to all Americans who do not wish to buy healthcare and you pay the penalty directly to them, then it's a direct tax!  In order for it to be Constitutional, it must either be an apportioned tax or Congress must pass a Constitutional Amendment to allow for an unapportioned direct tax on those who are not willing to purchase healthcare. 

I think it is quite clear that the Supreme Court was grasping at straws in order to get this legislation passed, which is an absolute disgrace to this country.  This is unadulterated bench legislation because in order to argue Constitutionality, the Supreme Court must have applied their own definition to the term direct tax.  This is also very unfortunate because this decision will further open the door for Congress to increase its power under the tax code.