It should’ve been clear to us that the Tea Party movement had a very different interpretation of what happened on Wall Street than most of us did. In principle their rallying cry is President Reagan’s old refrain, implausibly-applied: “Government is not the solution. Government is the problem.” Reflecting a cognitive interpretation of the same sentiment, Republican presidential hopeful Governor Mitt Romney said in August that “Career politicians got us into this mess”–meaning the 2008 Financial Crash and the Great Recession–“and they simply don’t know how to get us out.”
A Conservative friend recently posted a von Mises Institute opinion piece calling the animus of the left-wing “Occupy Wall Street” protest movement misplaced. In Axel Kaiser’s view, it is Federal regulations that caused banks to invest and borrow perversely, not the freedom and agency of investment banks and hedge funds that expanded the credit market into a customer base with little collateral and uncertain prospects, offering them borrowed money. This is a typical Conservative explanation for the Financial Crash, though it telling took the right a long time to get this story straight. Those whom are interested should read Mr. Kaiser’s account–not because it is correct, but because we should not be insensible to or ambivalent about the organized group of radicals in our midst. They blame generations-old institutions for the spectacular collapse of a barely-regulated Wall Street. They uphold the problem–a mentality conducive to anarchy in our large and fast-moving financial sector–as the solution. I want to challenge this argument at length; while it is expressed discreetly and eloquently, it is still a dangerous canard. The history of our financial markets in the past decade is too important to be re-written by apologists.
Mr. Kaiser seems to be well-read and reasonable about a great many subjects; however, I didn’t feel that way about his economic theory or his moral philosophy. Attacking what he considers a philosophical premise of contemporary Liberalism, he says that “the idea that the common good or the general interest is something different from the sum of all individual interests, and that government is a separate entity that through coercion can elevate society to a higher degree of moral perfection and happiness” is a falsehood. I promptly begin to doubt his judgment. Government is “a separate entity that through coercion leads society to a higher degree of moral perfection and happiness.” This is not a position that necessarily enjoins socialism; it is the justification for a government’s possession of military and police force. Does anyone deny that absolute defense of reason through coercive capacity which Thomas Hobbes describes in Leviathan?
“Whatsoever therefore is consequent to a time of war, where every man is enemy to every man, the same consequent to the time wherein men live without other security than what their own strength and their own invention shall furnish them withal. In such condition there is no place for industry, because the fruit thereof is uncertain: and consequently no culture of the earth; no navigation, nor use of the commodities that may be imported by sea; no commodious building; no instruments of moving and removing such things as require much force; no knowledge of the face of the earth; no account of time; no arts; no letters; no society; and which is worst of all, continual fear, and danger of violent death; and the life of man, solitary, poor, nasty, brutish, and short.”
Having the same rationale in mind, the sociologist Max Weber later described the state as “a monopoly on the legitimate use of violence.”
The government which exercises military and police power in order to protect people’s lives and property is itself never “the sum of all individual interests,” and it is not and cannot be sanctioned in all its resource-consuming actions by unanimous consent of those over whom it wields power. Again, the fact that the state’s sovereign capacity for violence elevates the general morality in deed and even thought is not an argument that enjoins socialism—though I will admit that I find the arguments distinguishing the right of the state to protect people from the harm of intentional criminality or from unintentional market or environmental effects to be circular and unconvincing precisely because I acknowledge that this is exactly what government does.
Kaiser has a much stronger argument than the one that rules-out government’s right to regulate our economic activity, and that is skepticism of the government’s capacity to regulate this activity efficiently and justly—that is, his invocation of “the diverse and irreducibly complex world of individual interests.” But while this is a stronger argument it is also a more-flexible one; episodes of waste in resource-allocation by government or long periods of crude handling of an economic activity by government regulators may constitute an argument for cutting this program or reforming this regulation (or a parable about the limits of what regulations can achieve) but it neither de-legitimizes nor repudiates government regulation as such.
The article is at its analytical weakest in assessing the origins of the 2008 Financial Crash—which is, of course, its objective. Fannie Mae was created back in 1938 as part of the New Deal, in order to promote and finance homeownership; Freddie Mac was created in 1970, essentially as an extension of Fannie Mae’s mortgage-financing operations. “(W)elfare programs to make true the progressive “homeownership-society” dream in the United States created the structural conditions”—or so Kaiser argues. This is a weak hypothesis; an argument that a 70-year-old government program is the sufficient culprit for a financial crisis which simply ignores the fact that the spiral of toxic debt played out in investment banks and hedge funds that had become far more-complex in their asset management, more risk-prone in their investments and more deeply-indebted than any government anywhere in just the decade preceding the crash fails on its own terms.
Former Wall Street Journal reporter Scott Patterson wrote probingly about this phenomenon of the conceit of Wall Street’s reigning specialists in his book The Quants. (I reviewed this book–which I love–1 year ago on this blog.) Wall Street’s hedge funds and investment banks had become dominated by computerized fast trades based on highly-abstract statistics and modeling. They did this based not upon knowledge of actual market conditions or long-term investment in a company but on inductive bets that shares of certain companies were over- or underpriced. These transactions were essentially unregulated, and they directed trillions of dollars of assets. Malinvestment, yes, but are we sure this anomic crash is about interest rates?
Mr. Kaiser reveals a disinclination even to distinguish between the subcomponents of government power he finds to be illegitimate—namely, its capacity to create entitlements and its power to regulate the economy. From what is intended as his climactic red meat: “…Because people do not understand that the source of the crisis was government, as Bastiat predicted, they now go on the streets demanding even more of what caused the problem in the first place: government. That is the paradox of the outraged.” (One could argue that he is referring to those “Occupy Wall Street” protesters who have demanded maintenance or expansion of the welfare state and not to those who have called for tougher scrutiny of the financial sector, but if so I would still level the same charge of obtuseness in thinking on him for targeting for critique a movement without a coherent message and never bothering to define it.)
Mr. Kaiser doesn’t do much better when he claims that “The dramatic rise in the price of raw materials and agricultural commodities since 2008 is basically the result of the inflation created by central banks.” I don’t know how many serious economists would sustain this argument. In spite of 2 rounds of “quantitative easing”—Dollar-creation by the Federal Reserve to promote currency flow through the economy—inflation is low by historic standards. The rate of inflation has been much lower under Ben Bernanke than under any other Chairman of the Federal Reserve for over 30 years. That’s a weirdly-basic fact for Kaiser to overlook when he seeks to attribute a cause for price increases in commodities. That increased consumption by large developing nations such as China and India and political volatility in countries producing such commodities (such as the states of the Persian Gulf or the tragically-misnamed Democratic Republic of the Congo) could be the reason for the price increase actually seems not to have occurred to him. While we’re speaking about ideologically-misplaced outrage, Mr. Kaiser is also circumspect about whether the price of commodities such as precious metals has been driven up by Monetarist Conservatives such as presidential candidate Ron Paul, who essentially exhort their followers to hoard gold, resulting in the obvious overpricing of those strategic metals. The latest also-rans to join this Monetarist survivalism are probably going to lose money on account of their reactionary opinion-sources.
Mr. Kaiser’s criticism of the Federal Reserve’s role as “lender of last resort,” including its power to bail-out insolvent but strategic American banks, skirts the central question: If the Federal Government should allow insolvent banks of any size to go into bankruptcy “like any other enterprise in the real economy,” what happens to the cash assets of those who deposited money in that bank? The Federal Deposit Insurance Corporation currently insures the first $250,000 you deposit in a bank; if a bank is allowed to declare bankruptcy, should the FDIC simply pay-out as much as its rules permit for all depositors? Where does that money come from? Wasn’t the 2008 Wall Street bailout actually a more-just outcome than this would have been? Or in the absence of the Federal Reserve—which predated it by 20 years—shall we dispose of the FDIC as well? Should you as a depositor be every bit as responsible as the bank to which you entrust your cash if your assets are lost in a series of ill-conceived and unredeemable loans? Kaiser seems to consider such questions beyond the scope of his article; considering his many strong claims, they are not.
Immediately following his objection to the Federal Reserve’s role as “lender of last resort” he adds that “In addition to this perverse incentive, banks work under a fractional-reserve system, which allows them to operate with very low capital reserves, so that their owners have little to lose if the bank goes broke.” As a free-marketer, Mr. Kaiser presumably would overlook the regulatory response to this problem that I would consider most-intuitive—simply limit the amount of deposited or invested cash that the bank can lend-out again—and insist that banks be told they’re on their own. Surely this would make them more-prudent investors of their depositors’ money! The problem with this narrow fixation on the “perverse incentive” of the Federal Government’s protection of banks’ assets is that it is based on a strained but ultimately-unfalsifiable assumption: Protections against a worst-case scenario provided by the Federal Government make bank executives indifferent to the collapse of their lending schemes. The strange claim that the loss of billions of dollars shouldn’t be sufficient incentive to lend depositors’ money prudently but the belief that they will at least remain in business suddenly makes them heedless to risk aside, the fact remains that the Federal Government didn’t save Lehman Brothers, which went very-much bankrupt. Around the same time Merrill Lynch was bought-up by Bank of America at 61% less per-share than its value in September 2007, a year before the Crash; the previous March Bear Stearns had been bought-up by JP Morgan Chase, for just 7% of its per-share value from 2 days before, when the Federal Reserve pledged a $25 billion bailout. How can all these Conservative opponents of the Federal Reserve seriously argue that all these bank executives and hedge fund managers were operating in a risk-free environment? 1st of all, this would have been a totally-speculative conceit on the part of bank managers—one strangely absent from both exposition and criticism of our supposedly rock-solid financial sector before the massive Federal bailouts of 2008. 2nd, the Federal Reserve couldn’t save Bear Stearns, and apparently didn’t think to save Lehman Brothers or Merrill Lynch. If the regulators were so slow to bail-out Wall Street that some of its major financial institutions collapsed as crucial weeks slipped by, this strongly-suggests that the extent of collusion charged by Fed-skeptics is a fantasy.
Bear Stearns used money borrowed from a variety of sources and backed its investments with credit-default swaps—essentially paid insurance policies for other investors to cover their loans to subprime borrowers—resulting in a leverage-to-assets ratio of 35.5:1. If the Federal Reserve Bank (95 years old in 2008) and the Fannie Mae/Freddie Mac complex (70 years old) were the primary catalyst of the events of 2007 and 2008, there is no explanation why the Crash shouldn’t have happened much sooner, pertaining to financing of some other sector of the economy. But the size of hedge funds, their connection to investment banks, and the extremes of borrowing by banks both from vast foreign capital markets and through sophisticated “financial engineering” had only become dominant in the financial sector throughout the decade prior to the 2008 Financial Crash. None of this can be blamed on government.
Mr. Kaiser’s moral sense is at low ebb when he subversively argues that income inequality is only a moral issue when the human actions that cause it are demonstrable:
“It has been argued that inflation and the lack of economic liberty are central causes of poverty and inequality. (Left-wing French public intellectual Stéphane) Hessel does not acknowledge this fact, declaring himself outraged by inequality in general. He says it is outrageous that in poor countries people live on less than two dollars a day. Two things have to be said in response to such claims. In the first place, there is a reason to be outraged only when inequality is the result of arbitrary confiscation, fraud of any sort, or bad economic policy. But when inequality is the result of freedom, there is no reason to be outraged at all, especially when everyone has enough. Only envious people can be outraged by the wealth some have legitimately gained…”
No, it is not the case that one must be envious to be outraged by extremes of wealth; it is enough to believe that poverty does graver harm to a given society than taxes. Mr. Kaiser sidesteps the real issue: It is not that some people are very rich, but that some people are very poor. That the true cause of the outrage Mr. Hessel expresses could elude him is remarkable; Kaiser even cites him objecting to poverty without mentioning wealth! Dispossession due to arbitrary confiscation and bad economic policy are indeed ruinous and outrageous (though I can’t recall the last time I heard a Conservative speak out in favor of native claims settlement—a blind spot perhaps enabled by John Locke’s implication in his Second Treatise of Government that American Indians had no right to lands they hadn’t cleared for agriculture). But fraud is equally-outrageous. What is Kaiser’s opinion of Goldman Sachs’ $550 million fraud settlement? Goldman Sachs settled a case in which they were charged with helping a hedge fund profit off of credit-default swaps for subprime mortgages that they expected to default, thus prompting the credit-default swap to be called-in. Goldman Sachs designed these credit-default swaps which they expected (intended?) to be insolvent and sold them to investors; at the same time they were selling subprime mortgages to working-class people they had just made a bet would default on their loans! The Federal Government had nothing to do with this; when trying the fit of the old Fed—Wall Street collusion yarn, note that Fannie Mae and Freddie Mac had staked their assets on the opposite “bet.”
Furthermore, what about poverty? Kaiser writes as though his argument that circumstances of commission that create poverty are an outrage while circumstances of omission that impoverish people are not is self-evident; in actuality it is ideological and highly-contentious. It is based on a primitive bias in our thinking—the “do no harm” fallacy. This fallacy argues that bad results of human intervention or agency are more serious than those which are foreseeable but which only occur when humans fail to act. This is an intuitive distinction; it is also sometimes a very callous and even an impractical one. At its essence it amounts to arguing that a mugger who beats his mark badly and runs off with her money has committed an outrageous act while a passerby who witnesses the incident and does nothing to help the incapacitated victim afterwards or to report the incident has not “committed” an outrage because he is not obligated to help. Kaiser makes the bizarre jump from Hessel’s professed outrage at poverty to the suggestion that such anger must be motivated by envy at the luxury of the rich. From the time I was 1st aware of it I never begrudged the rich their wealth—but when I encountered poverty, which is thick on the American landscape, I concluded that viable measures to reduce it had their own legitimacy and should always be a subject of political debate. I’ve seen people who would probably die without government assistance; the idea that such government assistance is illegitimate because of abstract concepts is more morally-odious to me than envy.
What is most-unfortunate about this article is simply what it indicates about many Conservatives (in contrast to the simultaneously more-identifiable and more-diffuse term “Republican”): They have not taken the 2008 Financial Crash as an opportunity to learn anything. This is tragic. The issue isn’t that they are still Conservatives—say, that they haven’t embraced President Obama’s 2009 or proposed 2011 Stimuli or his 2010 Health Care Reform, or that they are not a party to the current Wall Street-bashing or even their increasingly-vocal contempt for the new Dodd-Frank financial regulations. It’s that so many of them embrace the bizarre idea that their intellectual integrity requires them to believe, post-September 2008, only what they believed pre-September 2008. If the goal really was intellectual stasis, then mission accomplished: Having believed that a government program to promote homeownership was illegitimate, they now find that it is responsible for the worst financial crash since the Great Depression! Believing that a then-95-year-old institution that can influence the value of the US Dollar by fiat is somehow alien and unnatural, they find that its imposition of low interest rates must be the enabler of the malinvestments that led to an outbreak of foreclosures around our country and jeopardized the nation’s banks. The fact that hedge funds controlled trillions of dollars in cash, were virtually unregulated, able to borrow billions of dollars worth of foreign currency from any other country in the World—whatever the local interest rates might be—and to (theoretically, at least) insure each others’ loans through credit-default swaps (thus making underwriting subprime borrowers’ debt very profitable in the short-term), are all unworthy of mention, in the author’s view.
I immediately want to acknowledge that the author maintains an even tone and even some level of sympathy for his political opposites; being able to attest to his emotional grounding, however, I find myself surprised and frustrated by his failure to elaborate on his charges about the importance of New Deal-era “structural conditions” to relatively-recent events. In his fixation on an obviously-saturated and undisciplined “Occupy Wall Street” social movement rather than any actual arguments, whether lay or academic, that blame market finance for the Financial Crash and the Great Recession the author has failed to address the dominant narrative that would validate his claim that the protestors’ anger is misplaced. Applying an ideological assumption to a new and surprising development—which, like the rest of us, none of their ilk had predicted in advance—is not thinking. Whatever one’s commitments may be, ideology must become unfixed and permitted to drift with the absorption of new and incongruous phenomena for any thinking to be done. Rote ideology-application falls somewhere between recitation of a speech or the application of a mnemonic device.
I have changed my mind about a few matters since 2008. From an ideological perspective, I no longer think that promoting homeownership is a sound goal for the Federal Government—though I still believe it was historically. I will frankly admit that I was no more aware of the instability of our financial system than most people before 2008; I prefer stricter regulation and oversight of Wall Street now because of the extreme intellectual conceits and risk acceptance of our supposedly-brilliant “financial engineers.” The deficits we were running before fiscal year 2009 didn’t bother me; the deficits we are running now do. The wealth inequality in our country before 2009 didn’t disturb me greatly; its abrupt increase since the Financial Crash has—enough so that I am a recent convert to the idea of raising taxes on the rich.
So: While we may be skeptical of the ramshackle “Occupy Wall Street” movement for blaming corporations for all our problems, rashly personalizing Wall Street’s errors and improprieties, for calling for cuts in military spending (Who is going to enforce the most-urgent UN mandates? China?), or for simply having no agenda at all, this doesn’t mean we should let rehearsed but unreflective Conservative activists change the subject. While it has turned a massive profit over the past generation, the past 4 years or so have revealed that the “financial engineers” are not the masters of our complex and interdependent World but a volatile compound in it, both useful and combustible. Conservatives elide the difference between anecdotes of bad government regulation and the very legitimacy of government regulation itself. Lacking the inclination to consider compound solutions for the complex problems of interdependence, they imagine that “good” consumers, businessmen and investors can protect themselves from shocks caused by “bad” ones.
But in today’s politics it is not Conservatism that is philosophically-underdeveloped but Liberalism. What we need now is not a renewed commitment to freedom”—the Tea Partiers and Congressman Ron Paul will gladly squeeze all the water out of that stone for us—but a compelling intellectual defense of the social safety net for an age of inflating benefits and diminished fiscal resources. We also need a clearer concept of a properly-restrained financial sector. On that note I’d like to quote Kaiser’s own closing:
“…If people get outraged for the wrong reasons, they will inevitably demand the wrong solutions, making the problem worse. It is especially irresponsible, in these times of social upheaval, to call for outrage and resistance without first a clear examination of what is wrong and how the problem should be approached. This is the role of intellectuals and opinion leaders…”