18 Apr 2011

The biggest government failure

Warning: Angry rant ahead. I've gotta get this off my chest.

Market failure occurs when firms trading in the market create harmful negative side effects; the conventional response is to regulate or tax those activities, e.g., auto pollution.

Government failure occurs when activities delegated to politicians or bureaucrats are mismanaged to the point when society would be better off without government "help;" the conventional (but rare) response is to end those activities, e.g., government telecoms or wars.*

This post is about government failure with respect to the financial markets.

It's appropriate to post around tax day, as we contemplate what value we received for our tax payments.

Here's the short version: Government regulators and politicians have cooperated with Wall Street to create one-way bets in financial markets in which Wall Street makes the profits and tax payers take the losses.

The long version: Here's some evidence/argument in support:
For a concise summary of the issues discussed above, watch Inside Job (winner of the 2010 Oscar for Best Documentary). Inside Job -- unlike some of Michael Moore's stuff -- is accurate. The most shocking and appalling segment (for me) is when "respected" economists like Martin Feldstein (Harvard), Frederic Mishkin and Glen Hubbard (both Columbia) all look straight in the camera and say that they see no conflict of interest in writing reports praising deregulation in Iceland or financial derivatives that they were paid to write.** Hubbard looks like a total asshole (in my limited experience, he's not a nice guy); Feldstein looks like the cat that ate the caged bird; Mishkin at least looks awkward as he admits he was paid over $100k to write a report on Iceland that was based on his theoretical ideas of how markets are efficient and regulators do their job.

Let me repeat that: You can see that these guys were relying on theory in proclaiming the stability and efficiency of those markets. First, because they use typical jargon connected with those ideas. Second, because those markets had not experienced any macroeconomic shock sufficient to test their stability.

If I was the Dean, I'd revoke the tenure of all three. I'd fire them for disservice to the academic community (fraud) and their employers (theft while on payroll). They can go back to Wall Street, where there are no ethics above making money/

Let me back up and provide more background on my thoughts (just to be thorough):
Oct 2008: Does Wall Street matter? Yes, but they also caused this mess.
Feb 2009: Better to let the business cycle run; don't stimulate or bail out.
Apr 2009: Economists are useless if they mislead us on market policy.
Jul 2009: The Great Recession Conspiracy (Jim Taylor made me co-author; I agree with 80 percent of it.)
Aug 2009: Academic economists don't understand real markets.
Oct 2009: Please save capitalism from the Capitalists.

In recent days, we've got these updates:
Bottom Line: The government of the US (Bush and Obama) is somewhere between incompetent and criminal in its continued efforts to give away $trillions of our money*** to the richest of the rich.

* More on government services at Poll Results -- Tradeoffs and why I support Tea Baggers (only about 10 percent true, alas, they are pretty ridiculous these days)

** I've declared payment on a paper I wrote; it was rejected by an editor because it was "obviously" biased. He had a poor grasp of causality, but at least he knew that someone paid to hear my opinion.

*** As an expat with outside options (another passport), these shenanigans make it much easier to write off the US as a basket case of mismanagement (for my thoughts on pure evil, read an upcoming post on the Deep State). I started thinking about exile while traveling in the 1990s (remember the circus around OJ and Monica that diverted interest from real problems?), but Bush II put every thought into overdrive. These thoughts are very sad for me, since most Americans and most of America's culture and institutions are really great. America is ranked 22nd in the world in corruption -- not as bad as Zimbabwe, but not very good.

**** Here's an interesting Q&A with an average Wall Street banker.

Addendum: I met Michel Camdessus (ex-head IMF) this morning and asked him about bailouts, etc. He deferred comment on the US system, but praised that the French government's actions towards ensuring stability (a real risk) and maybe making money from "liquidity services." But his answer and the discussion was slightly awkward.