- Convolution is my M.O.: I tend to wander and address issues as they come into my head, but the tangents are intended to make my argument more relevant and to add texture.
- Lack of expertise: I am not an adroit financier or economist; I do not have access to all of the numbers; I cannot definitively say "whodunnit," but I do have an opinion about where ultimate responsiblity lies.
THE FOUNDATION
Likely Outcome of the Emergency Economic Stabilization Act of 2008
Now that I've got that off of my chest, here we go with a few fundamental questions and answers that I believe should be addressed before presenting an argument on this issue. First, what are the likely immediate consequences of either passing or rejecting the Emergency Economic Stabilization Act of 2008? Withholding: From what I can tell, the general consensus is that the American economy will sink into further recession, meaning stagnation in the economy: further inflation and higher unemployment rates. Applying: stabilization at best, most likely a continuing decline over medium-term despite projected first day gains in the stock market.
The Role of Federal Government in the United States of America's Economy
The role of government is to actively participate in the economy to create an environment wherein market forces may work unimpeded when functioning properly (that does not always mean profitably), and intervening at times to rectify market failures (not firm or sector failures). I wish that I had ample historical/anecdotal and Constitutional knowledge to make a stronger argument on this subject. In my group of friends, several made references to the words of George Washington as an authority because of his well-deserved and respected position of the ultimate Founding Father. We have looked to him for clues about who we are as a nation, and thus how we should behave in this situation. I like the appeal, personally, though looking at him alone is not complex enough for research ofthe essence of America.
Even in the first administration there was an intense debate about the role of the federal government in the economy, and largely because of the lifestyle and governmental style that different roles best supported. Washington, Jefferson, and Adams (among others) deplored extensive government intervention, especially when Secretary of the Treasury Alexander Hamilton proposed several government programs to strengthen and bolster the American economy in its infancy. They wanted a weaker central government that allowed for a decentralized agrarian lifestyle. In addition, many of them were influenced in 1787 by Smith's work on capitalism from 1776.
Hamilton, on the other hand, wanted to strengthen the government to kickstart a new industrial sector, backed by strong credit and a central bank. After convincing Washington of the need for a strong central government, Hamilton's department assumed the states' individual debts. This move consolidated foreign debts in the federal government to begin building credit in the United States of America, and to make sure that key financial players had a vested interest in helping the fledgling republic survive. The United States of America, from very early on, intervened in economic affairs as an enabler.
In this early case of intervention he created a credible government that could both provide loans and repay its own. He launched his programs -- the more extreme of them failing -- setting precedent for wise government intervention to create and protect markets, but not by buying out firms. Again, since the inception of the United States of America -- under the rule of President George Washington and Secretary Alexander Hamilton of the Treasury Department -- our economy has been a hybrid system of capitalism and government guidance. On a continuum where unadulterated capitalism (lassaiz-faire) and unadulterated communism (command system) represent ideological opposites, the U.S.A. does own a position that is closer to capitalism, but it incorporates some elements of command into the system.
Forms of Intervention
The form that government involvement takes is also important to review. We are all familiar with government regulatory bodies (FAA, FDA, etc.) that set a standard for particularly delicate markets, where the interaction between the produced good and the consumer can be dangerous if not monitored carefully. (Arguments could be made that a regulation serves as a market-wide indicator, around which competitors hover, in theory never dipping below it, though seldom deviating from it in even a positive direction.) I am not opposed to government regulatory boards, and our firms do respond to regulation (i.e. gas mileage standards for light trucks, and I believe now on sedans in certain classes), but I wish we had firms that were wise enough to grow without them.
A second form of government involvement is intervention in a market failure where participants in the market fail to properly internalize externalities, whether positive or negative. For example, a private corporation may not provide infrastructure because it could not regain the cost, though society itself would benefit greatly. That could also include emissions limits, where each firm may monetarily receive far more benefit from polluting, though the aggregate pollutions of each self-interested party would ultimately degrade the utility received by any of them (see Garrett Hardin's "Tragedy of the Commons" or just read Malthus to catch the idea better than I can convey it). I personally support legislation that better educates people about externalities, as well as active involvement in those affairs where it appears unlikely that individual members of the market will take any action.
A sub-category of the preceding type is for the government to lower the barriers of entry to a market that shows important and strategic long-term value. While the extent of the projected benefit is debatable, I believe that government funding of high-tech research & development, government matching programs for nuclear reactors, and alternative energy research grants are worthy interventions that would benefit the population in the long-term. In this case, firms cannot realize profits on their investments soon enough for their efforts to allow the firm to survive.
Third, the government may bail-out an industry that is facing disaster as a result of a force majeure (spelling?). Correct me if I am wrong, but I believe that this just means that forces beyond the control of the parties concerned inhibited the intended outcome of the [social/economic] contract. What exactly "beyond the control" means is up for debate as well, but here is what I consider a good example. The WTC and the Pentagon attacks in 2001 created unfavorable circumstances for the airlines that really no one inside the airline industry, excepting possibly the instructors who certified the attacking pilots, could be faulted for the extreme stress subsequently put on the airlines. The government stepped in to aid an institution that had previously behaved responsibly, I think, and that was so integral to American competition.
Finally, active-aggressive. The last form of government involvement, which I believe represents the current case as well as the case of LTCM, is active intervention to save a failed institution (not a market failure). In this case, excessive greed and blindness to the extreme risk of aggregate low-risk ventures created a financial crisis. Also perpetrating the crisis in its infancy, though unintentionally, were everyday Americans who sought ways to reduce their responsibilities, who out-leveraged themselves, and unwisely took on financial commitments that did not consider the reality of a slowing economy.
The Nature of Failure
The following section will say more about the types of failures in the market (not necessarily 'market failure') that the government may step in to intervene. I will briefly say that I believe that the crisis was caused by failed institutions and firms, not a failed market. Others could make the case that this represents a market failure of the textbook type, where the rational self-interest of each individual operating in the market produces negative effects for everyone (the negative externality). However, rationality is a function of perspective, and if bankers/financiers/lenders/borrowers had just read The Black Swan....I'll just include a note about the book. Its primary arguments are that reality is too complex to project; that the statistical extrapolations commonplace in today's financial system are dangerous because of that complexity; that aggregate medium-risk investments are more susceptible to a major shake-up or change (a Black Swan) than a portfolio dominated by low-risk with a smidgen of high-risk. Just review it; it's applicable.
Summary of fundamental assumptions: the American economy is a hybrid system that will experience further recession in the absence of a bailout plan, and possible stabilization in the event of government intervention; the form of government intervention is active-aggressive.
THE CASE AT HAND: EMERGENCY ECONOMIC STABILIZATION ACT OF 2008 (EESA)
EESA
Following shortly are kudos for some intentions of EESA. I support the bill's attempt to include federal investigative agencies (i.e. the FBI) in the financial sector to prevent harmful behavior (as presently defined, and as will soon be redefined by some legislation to come), and to punish wrongdoers of the malicious sort whether or not the bailout is authorized for the Secretary of the Treasury by Congress. I also agree with the bill's intent to create stronger regulations of the financial sector, and the recommendation to revamp the standard mortgage to include language about debt management in the event of difficult economic times.
We should also appreciate the bill's intent to create better regulations and guidelines that can ameliorate the short-term self-interest that we are prone to heed over better sense. More power to the government to create a more stable environment of law in which to operate. More power to the government to prevent excessive negative externalities and excessive risk-taking in the future. I do believe that EESA has some worthy goals: stabilizing homeowners market, potentially saving jobs in affected markets, ultimate restoration of credibility and confidence in our lending system, etc. Aside from the proposed offices of financial stability and the involvement of the FBI, there is very little about the bill that I support.
As I attempted to outline in the preceding section, the question at hand is whether government intervention of the active-aggressive type is acceptable for the type of failure addressed by EESA, and then whether the action is acceptable according to American principles of economy. I do not believe that a rescue plan that infuses billions of dollars into a failed institution (that does not meet the strict definition of market failure) is acceptable in this situation. I could be swayed by better understanding of the immediate causes and effects of the bill in question, but that is unlikely because of my aversion to the long-term implications.
Problems with EESA
· Engenders and propagates the problem at hand: overloading the debt-driven financial market from the bottom up, ignoring the extremely high-risk of aggregate medium-risk investments. "Be reckless and myopic, the government will save you if things get too bad." This mentality was exacerbated with the births of twins Fannie & Freddie, and won't die unless some firms die too. Just my thinking at this point in time.
· Power of the Secretary of Treasury: the Secretary is given power to decide who lives and who dies, and this seems wholly susceptible to natural human prejudices that we do not need to entertain. Nepotism, favoritism of other types, etc. We need people to learn their lessons.
· How are we funding the bailout? Does anybody else know? I do not know the specifics, but I do know that the government would work in conjunction with foreign governments and banks. Leveraging our national economy with debt to foreign entities is a no-win for all of us, especially if the Chinese finance our bailout. (I tend to view them as systemic rivals).
· Allow me to point out a flaw of EESA by critiquing a common critique of the bill. Some claim that the bailout helps the rich over the struggling homeowner, that homeowners are being made victims by the big, bad GOP elitists. This critique is disingenuous, as it ignores one of the fundamental causes of the crisis. True, big banks lent unwisely against [trash] assets in the form of mortgages, but individual homeowners unwisely (not illegally) out leveraged themselves and their foreclosures were the precipitating causes of the crisis. Both lenders and borrowers were guilty of the same crime, even if in different degrees: both saw an opportunity to get something for very little despite the actual risk. Not all risk is indicated in interest rates. The bill does not actually address all of the causes.
Some Related Trends?
We are [becoming] a hyper-service economy, and hypo-producer of things useful. Our military is producing some great technologies that will trickle, and our high-tech is doing tolerably well, but our economy is still top heavy. For a long time I have believed that we have too many commentators, analysts, consultants, lawyers (sorry), advisers, lobbyists; too many people who manipulate capital (i.e. financiers), and not enough people who go out and create it in the form of industry. True, we are getting along fine, but I just get very nervous when I see that our efforts are supportable only because less developed countries or developing countries are supplying our goods. What happens when those countries' economies evolve to the next level of capitalism that is banking, finance, and service oriented? This could just be the natural progression of a capitalist economy, but I would still argue that if this is the case, then maybe we need to retrench and recede until we reach a more sustainable and sane platform upon which to base our economy. Of course, here I sit writing commentary without a job...like I said.
We need all of those service sectors to improve and function efficiently, but let us not neglect the power and importance of manual labor, industry, and elbow grease.
The second related trend is the willingness to export accountability to someone or something else. Just think about how refreshing it is to hear someone take credit for failure in a mature and appropriate way; it's refreshing because we do not hear it that often. I am a bit of a pessimist, and have a tendency to see the worst, but I still believe that the character, quality, and actual commitment to principles are lacking in our culture. The commitment is to making money. The crisis is attached in too many ways to the American character to go unpunished as a failed institution should.
It is true that real estate is the foundation of any free world; possession of private property culminates in a "home", a place to live, and is at the top of anyone list. That is why this crisis is such a charged issue. However, far too many financiers and real estate agents rely on this as a form of magnetizing and collecting capital, not on actually creating anything worthwhile. In a speculative and debt-financed market, players got too greedy and were oblivious to the actual risk involved. What are the effects of this? From an academic standpoint (not from the hopeful unemployed newlywed that I am who is in dire need of a good job and could support the bill for that reason) I cannot support a bill that supports failure and does not punish a wayward market that could have prevented its own crisis. This is different that submitting regulations to prevent a recurrence.
SUMMARY AND PRESCRIPTIONS
Here is a brief synopsis of my thoughts. The crisis at hand may be termed a market failure, but there were multiple levels of crisis. First, the failure of both lenders and borrowers to recognize the high aggregate risk associated with their mortgage and lending schemes. Second, the government’s policies allowed for individual market players to legally behave unwisely because of the active change to government oversight policies (i.e. artificially trying to make housing more affordable). Third, well, the panicked herd behavior of all of us.
Assuming that application of the bailout money would stabilize the economy at best, and not improve it, the bailout's brightest legacy would be that government would intervene to save failed firms, and thus justify the perpetuation of similar risk taking in financial firms. The solution to this problem is not to save these companies now, but to allow them to suffer, to cause the American markets to reevaluate their values and operational procedures, and then to create regulations that could guide the market away from future failures of a similar kind. The solution is to educate families now, and then exhort them (yes, I said exhort) to teach their children sound financial principles. The solution is for us to read The Black Swan to grasp the futility of our plans, and then to read another more balanced book to make us feel better about ourselves.
We need to learn to recognize situations that may be prone to "tragedies of the commons" and to unchecked speculation.
P.S.
For those of you who appreciate world history, I will share a weakly related historical crisis between states (i.e. firms; lots of international relations theory is borrowed from econ): World War I. The Great World War is labeled by many scholars as an accidental war that no one really wanted; that Europe was a powder keg waiting for a spark. Rigid alliances, and similarly trained officers in each country that were blindly committed to the offensive style of warfare (despite changes in technology), and the prevalence of the security dilemma phenomenon set up represented systemic or fundamental causes of conflict. Also, the national pride of each country required a fight, even if they did not really want it. The leaders were too inexperienced or blind to realize that the situation was perilous, so they trudged on because of they didn’t, then their enemies would and take advantage of them. The precipitating cause of millions of lives lost, even if they came back from the war alive, was the assassination of Archduke Franz Ferdinand. That one event triggered a series of events that were allowed because of the structure of the system, the policies of the states, and the mentality of the people involved.
