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A History Lesson: The Role of Social Insurance and Gov’t as Risk Manager

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Taken from an editorial in The NY Times, the following belongs in that “(slap head) DOH!” category of Why-Didn’t-I-Think-of-That.

The financial markets had prided themselves on their expertise in pricing and managing financial risk prudently. But left on their own, they proved that they could not even manage properly as simple a transaction as a mom-and-pop mortgage loan, let alone fancy derivatives such as the collateralized debt obligations (C.D.O.’s) that were based on sloppily-written mortgage loans and the credit-default swaps (C.D.S.’s) meant to insure the value of these C.D.O.’s, but without adequate reserves to back up that credit insurance.

In the end, like teenagers who hate Mother’s strictures when all is well, but run to Mommy whenever they get in trouble, the swashbuckling oligarchs of the financial sector ran to government for cover, owning up once again to the time-honored mantra of this country’s legendary rugged individualists:

When the going gets tough, the tough run to the government.

Another term for “government risk management,” of course, is “social insurance.” […]

Perhaps the argument is that individuals should make their own financial arrangements in the private market for risk management to protect themselves against the financial risks of illness. But then it can be asked why states in disaster-prone areas — e.g., Florida and other states along the Gulf Coast — should not be required to tax themselves on a regular basis for the purchase of private insurance to cover the cost of their fairly predictable calamities, or to set aside adequate rainy-day funds to meet that cost.

Why is it the American way that I in New Jersey should feel obliged to give financial help to a family whose beach house in Mississippi was blown down by a hurricane, but it is socialist and un-American to help a Mississippi woman struck by breast cancer?

One of the most thoughtful recent books on the topic of government risk-management is “When All Else Fails: Government as the Ultimate Risk Manager” (2004), by David A. Moss, a Harvard Business School professor. The author clearly explains in this book why public risk management has become an essential and very popular form of government intervention in modern societies, including the United States, and even among its more staunchly conservative citizens.

Professor Moss explains that the first application of social insurance in our latitudes actually was aimed not at protecting individuals against financial risk, but at supporting the growth of modern capitalism. Its main instrument to that end was the legal sanction of the principle of limited liability of the owners of corporations.

Prior to this form of social insurance, the owners of a business were legally liable with their personal wealth for damages the business might have inflicted on others. With limited liability, the corporation’s shareholders are liable only up to their equity stake in the company. They can lose at most the value of their investment in the corporation’s stock. Beyond that, someone else in society — often the taxpayer — bears the financial risk for damages attributable to the corporation.

One wonders how many business executives and members of chambers of commerce around the country realize that the limited liability of shareholders is social insurance.


FT: What will Capitalism look like in the future?

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If you didn’t see CSPAN’s Washington Journal this morning, you may not know of the terrific series being run in The Financial Times. For the next couple of weeks, FT will be printing articles and commentary on “The Future of Capitalism.”

Under discussion worldwide is the form which capitalism will take – and should take – once the current economic crisis has passed. As Amartya Sen writes in Adam Smith’s market never stood alone,

The question that arises most forcefully now is not so much about the end of capitalism as about the nature of capitalism and the need for change. The invoking of old and new capitalism played an energising part in the animated discussions that took place in the symposium on “New World, New Capitalism” led by Nicolas Sarkozy, the French president, Tony Blair, the former British prime minister, and Angela Merkel, the German chancellor, in January in Paris.

The crisis, no matter how unbeatable it looks today, will eventually pass, but questions about future economic systems will remain. Do we really need a “new capitalism”, carrying, in some significant way, the capitalist banner, rather than a non-monolithic economic system that draws on a variety of institutions chosen pragmatically and values that we can defend with reason? Should we search for a new capitalism or for a “new world” – to use the other term on offer at the Paris meeting – that need not take a specialised capitalist form? This is not only the question we face today, but I would argue it is also the question that the founder of modern economics, Adam Smith, in effect asked in the 18th century, even as he presented his pioneering analysis of the working of the market economy.

These articles and editorial commentaries seem propitious right now, as Ponzi-king Berney Madoff is led off to jail and the Republican Party has abdicated its intellectual thinking to Rush Limbaugh. The years of reckless ego-gratification spending and moral abstinence may finally be over as people grapple with a new notion – or discussion – of what the best form of capitalism is…and how it should function.

For all the economic pain and fear that envelopes the human psyche right now, it’s a great time to be alive. I’m looking forward to seeing what comes out this crisis. If Adam Smith and Maynard Keynes were able to synthesize quintessential economic theory before WWII began, surely some bright new economic genius can develop a whole new theory of economics that fits both the world economy and humane requirements. Or at the very least refine Smith and Keynes for this new era of global economics.

Good reading!

Written by Valerie Curl

March 12, 2009 at 7:43 PM

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