So, Alan Greenspan admits a flaw in his ideology, that financial institutions really can't be relied upon to regulate themselves because it's in their own interest to do so. What's amazing is that he, a True Believer in the Gospel of St. Milton, admitted this. What's also amazing is how strongly he maintained that belief in a theory that -- his assertion of 40 years of empirical support notwithstanding -- never really held together.
I do feel sorry for Greenspan (though I feel more sorry for myself and all of us peons who are hoping that some day in the future we will be able to recoup at least some of our losses). I feel sorry for him because it must really come as a shock to find that the theoretical explanations you really believed were true simply aren't. And it's doubly hard to do that when it seems that this one flaw in your ideology has wiped out all recollection of your skillful balancing of inflationary pressures in order to allow growth over a lot of years.
Greenspan forgot that two major assumptions in his causal theory were just that -- assumptions.
Assumption 1: In a free market buyers and sellers don't coerce each other.
The truth is that coercion happens all the time, generally through fraudulent behavior, or business practices that are "legal" but are so misleading that they really, truly are fraudulent.
XM Radio just coerced me into paying $106.30 that I didn't want to pay. How? When I called to cancel my subscription, the "customer service" (Hah!) representative told me that he could not shut off my service right away so I could enjoy the radio until it shut off. (I told him I didn't want to listen to it. I don't like XM Radio. It's a waste of money.) He offered me 3 free months if I was willing not to cancel. I told him that no, I wanted to cancel. "Well," he said, "we'll give you the free months anyway."
Without my approval this person then recorded on my account a notation that I had agreed to continue my subscription after receiving a 3 month free promotion. THIS WAS A LIE.
I didn't know that this fraud had been perpetrated. So, I followed closely for a couple of months to make sure that XM was cancelled and that I wasn't charged for it any more on my credit card. Indeed, it seemed to me that the cancellation had happened as I had demanded.
Four months later (when I was no longer watching carefully), XM started charging me again for this service that I had cancelled. I didn't notice it at first -- I know, I should have looked at those credit card statements more closely, but I am (this will suprise you) human. It did not occur to me that a large cooperation would engage in fraud so I was not on "high alert." Eight months later I noticed the charges. XM refused to refund the fraudulent charges. Now I'm fighting with the credit card company.
It's government that is supposed to create the conditions in which these kinds of practices don't happen or when they do happen, our grievances can be redressed. It's government that we look to in order to prevent this type of cooercion, especially the kind of fraudulent business practices that even the emptor who pays the most attention to the caveats is likely to miss.
The mortgage crisis began with fraudulent behaviors like lying to customers and telling them they can afford mortgages they can't afford. Since the mortgage lender is seen by the mortgage supplicant as someone who is knowledgeable, the mortgage supplicant does not recognize when the mortgage lender is intentionally feeding him or her misleading information. Then somehow mortgage brokers dealing in subprime mortgages mislead others into buying those mortgages. Then rating agencies -- paid by the businesses they are evaluating! -- came up with ratings that were much higher for securitized mortgages than they should have been. Why? Could any of this have something to do with the coercion implicit in the rated paying for the ratings?
Assumption 2: In a free market, buyers and sellers have pretty good (if not perfect) information.
Intentional failure to disclose information, complexity of the information and the specialized knowledge that one would need to understand it, and false information are all prevalent in markets. The truth is, things are so complicated today that it's impossible for the buyers and sellers to really have good information. Oh yeah: There's plain old lying, too.
Look at the history of suppressed information about the health effects of cigarettes, and the more recent suppression of adverse effect information concerning Vioxx and Celebrex. How would some person entering the market (in other words, a patient who gets a prescrition for a drug) even know what questions to ask? How well can the average person decipher the medical journal articles that one might want to look at to see whether taking the drug is a good idea? And what's true for the complexity of medical information is also true of the complexity of insurance plans, derivatives, loans of all kinds, and more.
We need government to create conditions to make information flow more freely and truthfully. That's another kind of regulation.
Because assumptions about free exchange and pretty good information are wrong, free markets don't function unless government steps in to correct these problems (call them market failures).
Until there are perfect people, there will be no perfect markets. Unless governments create the conditions for fair commerce, we will not have free trade.
Friday, October 24, 2008
Thursday, September 25, 2008
Sometimes Chicken Little is Right
To be honest, I like to read the news as a citizen and not as a political scientist. Old news (read: history) becomes evidence for research. New news -- well, I just like to let things mellow a bit before I think they are ready for in-depth, theory-based analysis. Yes, as a citizen, I like to know what's going on, but I generally think there's too much noise in the daily news to make much sense of it.
But the current financial crisis cries out for real time analysis because Congress is being pushed to make real time decisions about incredibly large sums of money.
This crisis has been allowed to happen because people forgot or never learned a fundamental fact about the way markets work -- or not. Markets need the rule of law and they need regulation in order to function properly. The self-regulating market is a myth. Consider the simple example of how markets would simply cease to function if property rights were not enforced by government. I can't sell you anything unless I have a state-guaranteed property right that says it's mine to sell. Caveat emptor only works when there are fraud statutes on the books that make it illegal to fool me. Moreover, the state needs to force certain disclosures because markets can only function when people have the information they need to make rational decisions.
Yes, over-regulation can slow down an economy, but the lack of appropriate regulation, as we all too obviously see right now, brings a market down.
A key factor in determining how well-functioning a government is to look at "state capacity," which is generally understood as the ability of the government to maintain the rule of law, to collect taxes, and to do the things that government needs to do.
Too many years of deregulation mania and privatization dogma have eroded the state capacity of the United States. We're left with a bureaucracy that is inefficient, lacking in necessary funds, and failing to attract young, energetic workers -- and retain older ones. According to an April 2008 GAO report, "Governmentwide, about one-third of federal career employees on board at the end of fiscal year 2007 are eligible to retire between now and 2012" (http://www.gao.gov/new.items/d08630t.pdf, cited September 25, 2008). According to this report, 26% of employees of the Department of Commerce and 27% of employees of the Department of the Treasury are age 55 or older.
Now that our leaders seem to realize that we really do need to regulate, we have to ask whether the agencies in which you would expect to find the regulators are up to the task.
I knew nothing about mortgage-backed securities or credit debt swaps until the recent crisis hit the news, but I did know that markets were unstable, that privatization and deregulation meant that core government functions were being passed off to firms in the private sector that -- by their very nature -- were interested in maximizing profits rather than optimizing service to the customer/citizen, and that it's too easy to borrow. (Just use your credit card and pay only the minimum: Presto! You're a borrower. And you're a borrower at usorious rates)
For several years my students have heard me rant about how I think the fundamentals of the political economy have been rotting. The sky is falling!
And now it fell.
But it galls me to think that the big investment firms are going to be bailed out while people suffer. We ought to require that lenders renegotiate borrowers' debt so that payments can be made. (We have in the past gotten lenders to renegotiate sovereign debt; why not now make lenders rengotiate mortgage debt?)
We ought to increase capital gains tax as a penalty on misbehaving companies. Let them pay the American taxpayer back!
And we ought to demand that executive compensation be reined in. Shareholders and taxpapers are the losers which executive compensation is outrageously high. And I don't believe that the millions of dollars in annual pay buys better executives! I lived through the Ben Ladner years at AU where the cronies of the CEO (the University president) overpaid him because he was their friend, not because he was at all good at his job.
But the current financial crisis cries out for real time analysis because Congress is being pushed to make real time decisions about incredibly large sums of money.
This crisis has been allowed to happen because people forgot or never learned a fundamental fact about the way markets work -- or not. Markets need the rule of law and they need regulation in order to function properly. The self-regulating market is a myth. Consider the simple example of how markets would simply cease to function if property rights were not enforced by government. I can't sell you anything unless I have a state-guaranteed property right that says it's mine to sell. Caveat emptor only works when there are fraud statutes on the books that make it illegal to fool me. Moreover, the state needs to force certain disclosures because markets can only function when people have the information they need to make rational decisions.
Yes, over-regulation can slow down an economy, but the lack of appropriate regulation, as we all too obviously see right now, brings a market down.
A key factor in determining how well-functioning a government is to look at "state capacity," which is generally understood as the ability of the government to maintain the rule of law, to collect taxes, and to do the things that government needs to do.
Too many years of deregulation mania and privatization dogma have eroded the state capacity of the United States. We're left with a bureaucracy that is inefficient, lacking in necessary funds, and failing to attract young, energetic workers -- and retain older ones. According to an April 2008 GAO report, "Governmentwide, about one-third of federal career employees on board at the end of fiscal year 2007 are eligible to retire between now and 2012" (http://www.gao.gov/new.items/d08630t.pdf, cited September 25, 2008). According to this report, 26% of employees of the Department of Commerce and 27% of employees of the Department of the Treasury are age 55 or older.
Now that our leaders seem to realize that we really do need to regulate, we have to ask whether the agencies in which you would expect to find the regulators are up to the task.
I knew nothing about mortgage-backed securities or credit debt swaps until the recent crisis hit the news, but I did know that markets were unstable, that privatization and deregulation meant that core government functions were being passed off to firms in the private sector that -- by their very nature -- were interested in maximizing profits rather than optimizing service to the customer/citizen, and that it's too easy to borrow. (Just use your credit card and pay only the minimum: Presto! You're a borrower. And you're a borrower at usorious rates)
For several years my students have heard me rant about how I think the fundamentals of the political economy have been rotting. The sky is falling!
And now it fell.
But it galls me to think that the big investment firms are going to be bailed out while people suffer. We ought to require that lenders renegotiate borrowers' debt so that payments can be made. (We have in the past gotten lenders to renegotiate sovereign debt; why not now make lenders rengotiate mortgage debt?)
We ought to increase capital gains tax as a penalty on misbehaving companies. Let them pay the American taxpayer back!
And we ought to demand that executive compensation be reined in. Shareholders and taxpapers are the losers which executive compensation is outrageously high. And I don't believe that the millions of dollars in annual pay buys better executives! I lived through the Ben Ladner years at AU where the cronies of the CEO (the University president) overpaid him because he was their friend, not because he was at all good at his job.
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