A friend happened to point me to this article from economist Jeff Miron, who argues that the bailout is a terrible idea because of the effect of introducing a moral hazard.
I learned a lot about this phrase, "moral hazard", living through the Asian economic crisis of 1997-1999. So I felt compelled to write a response that I'm duplicating below...
Economists are, by confession, far more useful at near-equilibrium econometrics than at extrema (the edges of booms and busts) such as the one we're experiencing. This is also why idealogues for- and against-regulation are both wrong---best to let the system loose around equilibria (dereg) but need firm and swift clamping at the edges (reg). More simply, desperate times require desperate measures.
Furthermore the larger picture includes sociological and not just economic considerations. If I'm about to lose my job/my house/my family I don't much care about Adam Smith or moral hazards.
The same "moral hazard" arguments were applied across economies in Asia during the devastating dislocations of 1997-1999, backed by a then-naive IMF. Just look at the now-correlation between those that ignored/took that prescription and countries recovering faster/slowly-if-at-all and their doing well/poorly. Do these economists take massacres in Jakarta into account when talking about moral hazards?
I couldn't resist the bait, as it's a pet peeve... :-)
20081009
There Are No Atheists in Foxholes
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7 comments:
I have to say I whole-heartedly disagree with your basic premise.
Regulation will not solve the problem, for the government is at the root of the problem.
And as far as moral-hazard, you state you care much more about your own well-being. That sir, is a dangerous idea.
The idea that people can vote to legally expropriate money from certain citizens via taxation for their own financial well-being is tyranny that we have unfortunately condoned for some time.
http://matthewkovach.blogspot.com/2008/10/capitalism-is-only-way.html
Hi Matthew, thanks for your comment.
I wonder if you have understood my post sufficiently clearly. You sound rather intelligent so perhaps this is just baiting for a blog exchange :-)
There are at least 3 segments to this philosophical spectrum. For lack of a better nomenclature, let's call them (a) the Friedman Capitalists at the far North, (b) the Interventionists at the far South, and (c) the Pragmatists in the middle.
"Northern Friedman Capitalists" would argue for letting the Invisible Hand, and only the Invisible Hand, control everything, human suffering be damned. Because, they argue, in the long run that is the best economic outcome. We've also learned that in the long run we're all dead. And in some economic crises, real people do die, even in the short run. These facts are all true. So that debate really translates to a Machiavellian one.
As to the "Southern Interventionists" (I name them such because I can't think of a self-respecting economist in recent history who would take this extreme position, not even Keynes); they would have the government's very visible hand micro-manage every transaction "for the public good" because left alone a corporation entity would always act against the interest of the individual personal entity. Indeed the concept of a "profit-motivated good" didn't really come of age until recently, as presented in, e.g., Etsy and Winston's Green to Gold.
And then we have a group of Pragmatists who may variously: have seen the extreme edges of booms and busts of unchecked capitalism and their impact on human lives (life ain't that grand during booms, and can suck big time after busts); have built engineering systems and thoroughly understand the concept of linear and non-linear system behaviors; have directly experienced the cycles of many economies such as China, Viet Nam, Malaysia, Singapore, United States, Hong Kong, ...; have suffered greatly under communism and profited greatly through capitalism; and know ultimately that it is always best to "Do The Right Thing At The Right Time".
This group of Pragmatists knows that a Brownian system works well, and works best when entities are left alone to move about randomly while attempting to maximize their own self interest. They also know that such systems, like drops of ink in a water bottle, must also have limits at the edges. Some of them even agree with Friedman's argument for the valuable price signals sent from unregulated insider trading. Many were deeply suspicious of the Fed's move to suspend reporting of the M3 money supply measure in 2006. With fiat money being one of the ultimate government regulatory tools, some of them would prefer a return to the Gold Standard to keep inflation and governments in check. But these same people also agree with Soros's argument for a re-architecture of the financial system to avoid ever expanding and bursting bubbles and their painful ruptures at the edges, at which point issuing more money to address the earlier addiction is the only plausible answer.
And most of all, they are rational thinking people who don't care to reduce these arguments along Republican or Democratic party lines so the masses can vote with them based on a kneejerk response. They know intervention is needed to save society from financial collapse, but they are also deeply fearful of an extreme Sarbanes-Oxley-choking-free-enterprise-to-the-3rd-order response from the next US administration. And if history is any guide, over-regulation WILL happen. Boom-and-bust swings happen in policy making, too.
As to acting in one's self interest, I'm sure Adam Smith would approve. Isn't that the Invisible Hand that builds the Wealth of Nations? Or did I misunderstand the comment? Cheers.
I think your response, whether you realize it or not, betrays a fundamental error in your reasoning. Your argument against “Northern Friedman Capitalists” hinges on the assumption that “in the long run we are all dead.” You and many others may take this simply as self-evident fact, but I assure you, it is not. Where is the proof? In fact, if we look at the political systems that have caused the most deaths we invariably find National Socialism in Germany and Communism in the Soviet Union and China.
I think you mistake capitalism for fascism. Fascism is where the corporations have purchased all the politicians and manipulate the political system. Capitalism is based on objective law. If the government doesn’t involve itself with business, then certain businesses wont receive favor over other businesses. In essence, the government, not capitalism, causes the rise of coercive monopolies.
In a Capitalist society, businesses only have economic power. If they produce a product that people do not like or act in a manner that people do not condone the people can purchase from another business. Business can only provide what people want, but the government can do what it wants, regardless of what the people say.
As for government being necessary to avoid ever expanding and bursting bubbles, you fundamentally misunderstand the cause of bubbles. Bubbles are cause by easy credit, which can only be provided by the Federal Reserve.
Under a gold standard banks cannot loan out more money than they hold in tangible assets, so they are forced to finance only the safest of investments. When banks reached the limit of their gold reserves, they stopped lending, which cause a very brief retraction in the economy, interest rates rose, more people deposited gold, and the system was renewed.
The Government came up with the idea that if it simply gave the banks more money when they ran out, the economy could grow forever. Well, what happens when money is unlimited and cheap? People speculate, take huge risk and make poor-investments. This caused the speculation bubble that finally crashed in 1929.
As to your interpretation of self-interest, I do not believe Adam Smith would approve. Most capitalists endorse reasonable self-interest based on objective law. Do not mistake me for an anarchy-capitalist. You may pursue your own self-interest so long as you do not infringe on the rights of others. For example, my “self-interest” is to own 100 slaves, but my “self-interest” cannot overpower their objective right to freedom.
We create objective law and we enforce it against all breakers. Law is designed to protect individuals and their rights against force, regardless of whether it is force from a thief or force from the government. You seem to think that somehow “group freedom” can exist without explicit individual freedom. How can a group be free if 49 are slave to the other 51?
I would like to end with a quote-
There are two sides to every issue: one side is right and the other is wrong, but the middle is always evil. –Ayn Rand
Hi Matthew, the follow up contains so many strawmen I don't know where to begin.
I've lived too long and learned too much to think I have all the answers. I've worked in financial institutions & built quant systems that print a lot money off Wall Street so I do know a thing or two about capitalism, economics, and econometrics. I've also had my share of intellectually honest (and not so honest) flame wars.
And from looking at your profile, inferring your raw intellect, I suspect you will have the opportunity to acquire such knowledge and experience, too.
All the best.
I have to apologize if I seemed overly antagonistic, that was not my intention. As you've probably inferred, topics such as these are a passion of mine. Most of all, I do not want this to be a flame war.
In reference to strawmen, I do not see how I am being intellectually dishonest.
I understand, I think, what you mean to say though. My use of the terms "slavery" and "freedom" are too extreme to be used in this context and you think I have characterized you as a socialist, which I don't believe you to be.
Maybe its just the time of year, elections and all, but let me ask you an honest question.
Do you feel it is right for the government to pursue social policies with tax money, regardless of the amount of support for the policy? (i.e, 51% vs 49%)
Whenever I think of this question I can't help but to think of what Thomas Jefferson would say,
"To compel a man to subsidize with his taxes the propagation of ideas which he disbelieves and abhors is sinful and tyrannical."
Perhaps my ideals stem from my stance on abortion, among other issues. While slavery is indeed a strong term, I am still being coerced, not only to accept it in terms of policy, but to pay for it.
I find it immoral, but recognize certain difficulties in actually banning abortion based on differing and unprovable philosophies. But it seems that if we are to be fair, those who want it should bear the sole responsibility of financing it.
This however does create a slippery slope. At what point does the government have the right to use tax money for social goals? If not a 51%, then what about 60%? why 60%?
That is why I think, that in order to avoid situations like this, the government should never use tax money for social goals and it should be left to private charity.
This however leaves another problem, what is a "social" goal and what is a law that "fights unjust acts." Obviously we should have laws against racism, but when do laws against racism become "reverse-racism?" These are all very difficult questions, questions that I am certainly not qualified to answer.
That is the basis for my rationale for no government intervention. We cannot know the consequences of the government's actions in advance. The CRA seemed like a good goal, but it played a part (among many other parts) in the current crisis.
What are the consequences of our actions in relation to the bailout? Well, we cannot know. We don't truly know what will happen if we don't act, so we don't really know that action is in fact necessary or that it will really make things better. It is all essentially a war of differing conjectures.
I hope I've been clearer in my rationale, as I truly am trying to discuss this honestly.
Hi Matthew, thanks for your earnestness.
I believe that the price of admission into civil society is to accept that, as a social contract, there will be certain laws and policies that run counter to my set of beliefs and convictions. I can't pick and choose at will the laws I will follow and those I will not, if there is a way for me to effect changes by (a) working with the framework, or (b) leaving the system.
What exactly is no government intervention? Is enforcing a legal system of contracts intervention? Is the existence of the SEC a form of intervention? Is having a state school system intervention? Adam Smith himself acknowledged a range of "intervention" that are the purview of government. I actually disagree with him that the government is best at providing education; does that make me a greater capitalist than Smith? It is really a matter of a million degrees, guided by a set of strategic intents, no matter how purely you want to filter it.
On strawmen, one type is the process of radicalizing an interest to an extreme position---quite easy to do of any proposition. Extremism does have its value; extreme situations do simplify decision making. It's the in-betweens that test one's principles. I observe this in leading & managing execution all the time. And my conviction in in-between economic times is very much capitalistic.
In the case of the so-called bailout, we actually do know with reasonable probability what would happen if the government did not move to try to restore trust in the financial system. This is not idle academics. Governments have collapsed, homes have burned, and people have killed one another in massacres as recently as just ten years ago over such collapses. I have little sympathy for economic arguments that ignore such impact, and if that makes me a socialist, get in line, Karl. But I would like these economists actually to have a family member go through such a "transformative" experience, before making pronouncements far more appropriate for far more ordinary times.
I have completely bypassed mentions of the CRA or Clinton or bankers or Wall Street CEOs largely because they are irrelevant to the needed medicine, and because there is enough blame to go around. I believe I know the root causes of this bubble qualitatively and quantitatively earlier and better than the average person. That knowledge is irrelevant, or at least orthogonal to the original point of my post. I sense that we would be on the same side of the spectrum, with the exception that I know during extreme times my ideology must give way to pragmatism. I have lived through extreme times. And this is why I find absolutely no inconsistency in McCain's vote for the bailout. It is the only responsible thing to do.
In Production Engineering we have a principle when systems go down: "Stop the bleeding. Now. Do that post mortem later."
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