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.


Rich Mills said...

OK, this kind of article ticks me off. To paraphrase, the argument is, we're giving the nation's money to the rich people who don't deserve to have it by cutting their taxes.

Before I begin on why, a disclaimer: I made $15,000 last year and have two teenage boys living with me. Outside of a country like Bangladesh, no one can call me wealthy.

Here's my premise: we must choose between two competing versions of morality. Either a person is entitled to the money they earn, the corn they grow, the buildings they build and the sculpture they create, or they are not. If they are not entitled to these things, then other people are entitled to them. If they are entitled to these things, then no one else is. There is no in-between because there is no principle on which one can base a decision to take 25% or 50% or 75% that would not also allow one to take 100%. I myself am against the idea that "You work and toil and earn bread, and I'll eat it" (Lincoln). I believe that whatever you earn or build or create is yours; not two-thirds yours or one-half yours, but all yours. Therefore, a tax reduction for you does not take anything from someone else that they had a right to have. Period.

But don't pigeon-hole me as a boot-licking friend of the wealthy. It disgusts me when rich people get special rules written for their companies to protect them from competition, when rich investors get bailed out because their firms are deemed by some palm-reader from the government to be "too big to fail," when unions get bailed out at the expense of more ordinary investors (GM). To paraphrase Gordon Gecko: failure, for lack of a better word, is good. If the corner gas station can go out of business, so can Citibank. And the only reason companies get “too big to fail” is because government regulators subsidize their risks.

Here's a simple idea which few people latch on to: one reason regulations are bad is because the more regulations you have, the harder it is for ordinary people to navigate them while at the same time, well off people have the resources to hire the necessary accountants and attorneys to make them work in their favor. Here's something else to chew on. Every time there is an increase in tax rates on the wealthy, there is also an increase in the complexity of the tax code. When someone proposes, as Ryan has done, to decrease tax rates, it is usually coupled with a decrease in tax code complexity and fewer deductions and exemptions. Whether tax receipts will actually decline from such a plan is doubtful, especially when it is likely that more rich people will pay taxes because fewer of them will have devices in the tax code that allow them not to pay.

Bottom line: Cutting tax rates is not a giveaway, its letting people keep more of what belongs to them; and if you really want to hurt rich people, slash regulations.

David Zetland said...

@Rich -- I totally agree, and I wasn't talking about tax rates or taxes for the rich. I was talking about the service failure WE get for our tax dollars and where those dollars are going.

FYI, I favor a simple tax code (close to the flat tax) and taxes on property (harder to dodge).

I totally agree with your points on regulations and loopholes that favor the rich.

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