Tuesday, December 23, 2008

"Capitalism without failure is like religion without sin."

On seekingalpha.com, my Madoff article has attracted the second most comments. I've added a comment of my own, which I share below:

I've read all of your comments with the hopes that our outrage will prevent another ill-advised bailout. Carnegie Mellon economist Allan Meltzer once said, "Capitalism without failure is like religion without sin." In other words, capitalism doesn't work unless we allow losers. Having losers creates two positive outcomes: one, it shows others what doesn't work (in this case, not diversifying or not doing due diligence when investing); and two, it creates shame--a powerful motivator--by warning others that bad actions lead to real consequences.

A Madoff bailout would be particularly harmful to capitalism as a whole, because it would pervert it into a tool for the rich and well-connected. I called the WSJ article propaganda because it focused not on the investors who made substantial returns over the 25+ years of investing with Madoff, but on charities and the elderly. Thus, it was deliberately designed to pull on our heart-strings for a class of people who are generally well-off.

The real victims are non-Madoff investors who will suffer diminished returns from their mutual funds. Their mutual funds hold companies like UBS and other entities that invested with Madoff. No one will be bailing out these Main Street investors, but they are the real victims. Yet, all the attention is being given to Madoff's investors, who are a highly exclusive group of hedge fund investors and investors who failed to diversify their investments.

In the end, a bailout is wrong because it would cause the transfer of wealth from people America should support rather than penalize. Basically, rather than reward people for making wise decisions or providing utility to others, a Madoff bailout ensures that Main Street will continue to suffer for bad decisions made by the rich and investors who failed to diversify.

If we wish to serve as a non-exploitative economic model for the rest of the world, we must allow some failure. We must not allow well-connected investors to make bad decisions and then escape the consequences because of their friends in Congress, on Wall Street, and in the Dow, Jones & Company publishing firm.

More important, if we want the U.S. dollar to continue being the world's reserve currency, then we must ensure the rich as well as the poor suffer the slings and arrows of bad decisions. The alternative is printing more money, which will lead to inflation, and reduced stature.

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