Tag: Financial Crisis

Pattern junkies and the financial meltdown

In an opinion piece for Forbes, legal scholar Richard A. Epstein draws attention to the political philosophical aspects of the financial meltdown:

Fannie and Freddie didn’t design their horrific lending policies by chance. No, behind this lending fiasco lay the strong collective preference for the “patterned principles” of justice that Robert Nozick attacked so powerfully in his 1974 masterpiece, Anarchy, State, and Utopia.

Public policy makers attribute goals to society and look at its institutions, and ultimately people, as means to produce them. Such a teleological mindset stands in strong contrast to “historical principles of justice, which are content to establish the rules of the game and then let the legal moves by individual players determine the social outcomes.”

Whether “fairness” in the mortgage market or the creation of an “ownership society” is the goal, the underlying premise of society as collective enterprise towards “shared” goals is bound to create winners and losers and unintended consequences (which require additional interventions and so forth).

Epstein’s characterization of Congress as a  “pattern junkie” is very much to the point because, as a general rule, politicians cannot resist the siren song of using the coercive power of the state to overturn contract and spontaneous cooperation. As Anthony de Jasay points out in his treatise on political power The State, not intervening would require that the state has ends that lie beyond politics:

It seems anomalous if not self-contradictory for the state both to have a will and to want to minimize itself. For this to be rational, its ends must lie beyond politics, and be unattainable through governing.

Politicized money

Monetary policy is governed by the rule of men, rather than the rule of law. The results are what public choice theory would predict and monetary history has documented: booms, busts, and panics.

writes Gerald P. O’Driscoll Jr. in Money and the Present Crisis (PDF).

In the same issue of the Cato Journal about lessons from the financial crisis, Anna. J. Schwarz (PDF) identifies expansive monetary policy as one of the major causes of the financial meltdown. But in her collaboration with Milton Friedman A Monetary History of the United States, 1867-1960 the Fed was largely blamed for the Great Depression  because it did not engage in expansive monetary policy.  It appears that a Fed that is powerful enough to  avoid catastrophe  is also powerful enough to create catastrophe. The idea of a politically neutral Fed is becoming just as realistic as the idea of constitutional limited government but few economists advocate a complete separation of money and state.

Anthony de Jasay on the financial crisis

In his recent columns on the 2008 financial crisis, the economist and political philosopher Anthony de Jasay discusses a number of topics including the uninformed, sensational and self-fulfilling reporting of the mainstream media about the current economic climate, the non-trivial contribution of government regulation to the financial crisis, and the consequentialist thinking about the economy that is at the root of calls for government intervention.

Most, if not all, government policies involve economics. This fact alone explains the prominent place economics has in news reporting and the intense politicization of the science of economics. But this not does necessarily make the general public and politicians more informed about economics: “Complex questions of biochemistry are usually discussed by biochemists and those in civil engineering by civil engineers…Media men need not know much, but they know that good news is no news,” writes de Jasay. And, as has been documented by the economist Bryan Caplan, rationally irrational voters hold systematically biased beliefs about economics, whose views are again reflected by the politicians they elect for office.

De Jasay further writes:

It is barely thinkable, to put it mildly, that either the discount rate, or the sum of probability-weighted future profits, or their time pattern between fat and lean years, or all three together, should change sufficiently in less than a year to cut the value of all European companies by a half. Can we all be out of our minds?

Maybe we are, as the elasticity of expectations is greater than 1, fueled by a climate of media and politics-induced panic, which produces public policy responses that produce more panic and uncertainty, leading to even greater elasticity, etc.

One of the saddest and most depressing aspects of the 2007-2008 financial breakdowns is that panic was generated without sufficient objective grounds for it and without the intention to do so. The American mortgage default problem caused a loss to the lenders, mostly banks, estimated at just under 1 trillion dollars. This was in major part also zero-sum, for there was no destruction of real wealth and no loss of current production of goods and services; the mortgaged homes were still standing and were lived in by the original borrowers or could be rented out if foreclosed. The trillion-dollar loss was really a redistribution of existing wealth, painful but not catastrophic, nor really large in relation to a 14 trillion dollar American economy. – Trials and Tribulations of a Hybrid System

Is it possible that the panic mode was not so much induced by the state of the economy but was triggered by the redistribution of existing wealth that followed the meltdown of the housing and financial markets? The politics  surrounding the government bailout plans (“too big to fail”), seem to indicate this was a contributing factor. There is an urgent need for some insightful public choice analysis of the financial meltdown and the government’s response.

De Jasay reviews a number of the factors that contributed to the financial crisis such as low interests rates (although de Jasay does not single out the Fed), the pressure to issues mortgages to households that could not afford them,  Basel II and mark-to-market-accounting regulations, saying about the latter two:

The interaction of the two rules generated a vicious circle that reinforced itself with every turn. The whole scenario illustrates the potential of hybrid systems, such as the actual set of liberal elements mixed with dirigiste ones, for making a moderately bad initial disequilibrium into something very much worse…In a “pure” liberal system, durable success and profit maximization depend on gaining and retaining the confidence of depositors and other creditors. In a “pure” dirigiste system, it is not the customers that must be satisfied, but the regulators. In any hybrid system between the two, it may not be possible to satisfy either the customers or the regulators.

In his column Trudging Down the Third Way, de Jasay ultimately lays the blame at the crass consequentialist thinking that is dominating public debate about the financial crisis. Instead of respecting contract and property, “the economy” is perceived as a tool that needs to be manipulated to produce specific political goals such as  economic growth and redistribution of income.  It should not be a surprise, then, that a (perceived) crisis in the economy produces panic in politicians. The renewed calls for more regulation is often accompanied with statements that laissez faire capitalism has failed. How the heavily regulated economies of contemporary Western countries can be perceived as anything else than mixed economies ruled by pressure group interests and economic populism remains a mystery.

The political philosophy of bailout

All politics is redistributive. Although this is often hidden from view through appeals to the social contract, democracy, and the common good, the recent attempts to reward unsound business practices with taxpayers’ money make even the most sophisticated appeal to the “common good” look suspicious. Although advocates of liberty have offered persuasive accounts about the involvement of  the U.S. government and the Federal Reserve Bank leading up to the current “crisis,” the root problem is the teleological mindset that sees the market and government as instruments to achieve certain goals.

Looking at the (long term) consequences of an act is an important part of individual decision making.  This is so obvious that we are led to believe that such consequentialism is possible for society as a whole.  Political consequentialism can take two forms. In its first incarnation, it is assumed that society is a collective effort toward shared goals. This view regards society, and as a consequence “the economy,” as one organism. A good example of this mindset is displayed by Republican Senate Minority Leader Mitch McConnell when he says, “Our whole economy you could think of as the human body and the credit markets as the circulatory system.” Presumably, any measures that are made to restore circulation will benefit us all.

Unfortunately, we see a similar outlook on society among advocates of liberty who talk about promoting “growth” or “efficiency.” Although their policy recommendations may be less intrusive, the assumption of shared goals is the same. Equally troubling is the acceptance of concepts like “market failure” and “government failure” as if these concepts are purely technical in nature, instead of implicit value judgments.

In its second incarnation, different interests and values among individuals are acknowledged but it is believed that policies can be designed to optimize a “social welfare function.” This position is a non-starter on epistemological grounds, as evidenced in real life by the lack of consensus among its advocates. This should not be surprising because consequentialism is not possible without guesswork and making personal value judgments. As the political philosopher Anthony de Jasay has argued, at some point someone needs to make decisions that will be binding for all, and consequentialism will ultimately collapse into authoritarianism, plain and simple. Nevertheless, this view has obvious appeal to people  who advocate government intervention and redistribution of incomes.

In times of crisis (imagined or real), the latter position is simply abandoned for the former, as documented by Robert Higgs in his book “Crisis and Leviathan: Critical Episodes in the Growth of American Government.”

The interventions that led to the current problems, and the proposals to solve them, suffer from the same  activist, fanatical, mindset that looks at society and its institutions as something that can be “improved” through collective choice.