Saturday, July 17, 2010

Summer time reading

The 10th and final installment of Walter Russell Mead's essay: "The Top Ten Things We Learned From the Global Economic Meltdown".

10. The politicization of economic governance is dangerous business.

The economic system we’ve built depends heavily on a small number of global financial firms who necessarily enjoy close links to national governments. Because of their power and their wealth (and also because they are sometimes ‘too big to fail’), these firms can potentially control the laws that govern their behavior and the regulators who enforce them. In the United States there has been a lot of attention paid to the close relations between current and former executives at Goldman Sachs and the Clinton, Bush and Obama administrations. The finance-government nexus in the US has its counterparts in other countries as well. These close connections, and the obvious danger of conflict of interest, have gotten a lot of attention — as well they should.

But the problem of regulatory capture is much greater and more deeply entwined with our current economic structure than this one case. The rise in the economic importance of the state during the twentieth century–however necessary and in many ways benign this role may have been at various points along the way–inevitably brings politicized governance and regulation in its wake in ways that make bubbles, panics and crashes both more destructive and more likely.

To take one important example, when government workers make up a substantial portion of the electorate, they can influence their own wages and pensions by voting as a bloc. They can — and they do. California, Illinois and Greece have a lot in common.

But even this is just the tip of the iceberg. The increased economic role of the state naturally and inevitably multiplies conflicts of interest and creates moral hazard. American housing policy, widely and correctly blamed as a major contributing factor to the crisis of 2008, was an outstanding example. The combination of interest groups — consumers who wanted cheap loans and rising house prices, banks who wanted a safe and profitable business model, contractors and other businesses with a stake in the home-building industry, cities and towns whose tax bases increase with rapid growth, advocates for the poor who wanted to improve the access of marginalized groups to the Great American Wealth Machine of home ownership — put them all together and there was an irresistible political force driving the United States real estate market and the financial system into more and more dangerous territory. The housing bubble wasn’t an accident; it was the result of decades of national policy and we worked very hard and spent lots of money to make that bubble as big and as dangerous as it turned out to be.

“Vote yourself a farm!” was a slogan of those who campaigned for the Homestead Act that gave free farmland in the west to anyone willing to settle it. Farm subsidies from the Homestead Act through price supports helped cause the Dust Bowl catastrophe and the great agricultural depression of the 1930s by encouraging over-investment in farming and the creation of marginal farmsteads. The crash was more brutal because government support had inflated the bubble past what would otherwise have been its ‘natural’ size.

“Vote yourself a home!” has been our national motto for the last fifty years and today Americans are as addicted to the home mortgage deduction (and the even less justifiable deductions for second mortgages and home equity loans) as Greeks are to early retirement and government employment. Political popularity makes the policies harder to change — but no less damaging and destructive.

There is no easy way out of these problems. Global markets need sophisticated firms and large firms can manage risks and survive shocks that smaller ones can’t. Civil servants do not and should not lose the right to vote when they take government jobs. The decision to favor home ownership on social and political grounds is one that politicians can properly make, and there is a lot to be said for policies that have helped millions of American families acquire substantial equity over the years.

Yet it is clear that the mix of democracy and capitalism is a dangerous if necessary brew; after decades in which we failed to think the costs and risks through, we are now suffering the consequences of policies that create dangerously perverse incentives in both political and economic spheres. Reducing damaging but popular forms of state intervention in the economy while ensuring the state retains the authority and the ability to provide the effective legal and regulatory frameworks without which no modern economy can flourish is the fiendishly difficult and delicate task which Europeans and Americans alike must now undertake.

(italics, ours)

Don't count on this Wall St. reform bill to come anywhere close to striking that fine balance. We hate to look like Know Nothings but really... what more do you need to know about this particular piece of legislation than the fact it was written by Chris Dodd and Barney Frank?

Look for crony capitalism and "corporatism" once hated by that near-extinct animal known as "liberal" to become further entrenched by this bill.

Our blog buddy, Harrison, has a nice round-up of quotes and goings ons from Frank and Dodd that will only prove our point, here.

P.S. The image we have been using for this series is an allegorical painting by Hendrik Gerritsz Pot circa 1940 depicting Tulip Mania which many believe to be the first speculative bubble.

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