According to Austrian business cycle theory, artificially low interest rates create bad information which causes people to make bad decisions even as they are acting rationally given the information they have. We can see this in the housing bubble, and we can see it in the education bubble, with low-interest student loans driving it. Cheap money creates false signals. Distorted prices cause people to make what turn out to be bad decisions, made worse when the bubble bursts.
Now, if a business were to do this, were to misinform people about what they were getting, this would be considered fraud, and the business would be held responsible, not the victim of the fraud. However, we have people who were defrauded into buying houses and getting educations that have turned out not to have the value they thought they did, who bought houses and educations with cheap money, thinking they would have the value advertised, and who have seen that value disappear -- along with their jobs in many cases -- but who now are told that they "should have been responsible" and not gotten things they couldn't afford. But what if they could afford them at the time? Circumstances change. And, worse, they were able to afford something, at the time, that was said to have more value at the time than it turned out to have, while now they cannot afford this same thing that has decreased in value, but whose costs must still be paid. They have been defrauded -- but who is paying for it?
The Occupy Wall Street crowd think they have the answer: banks and Wall Street. However, these are but the secondary players, the secondary cause. They were acting rationally given their own bad information -- not to mention pressure from the primary players. It does no good to protest the secondary cause -- we have to protest the primary cause, the government and Federal Reserve which actively worked to create artificially low interest rates and have pushed for more higher education and more people in houses. To get what they wanted, the government created false price signals, including cheap money, to get the behaviors they wanted. Thus, they are responsible for this mess. And they should pay, and they should be the ones made to get us out of our bad situations -- again, something the OWS crowd have intuited to some degree, but without much economic understanding behind it.
The problem is of course that the government does not have its own money. It must tax or borrow (and tax in the future) to get the money needed to make things right. And of course everything they have done to date has done nothing more than maintain the status quo and continue to distort prices. Thus, in a financial sense, one cannot hold the government responsible for its idiotic behavior, because all we would be doing would be taking water from one end of the pool to pour it into the other end. Further, there is the problem of moral hazard, as people would begin to think that every so often the government will bail them out when they have made bad decisions (assuming everyone has made the same bad decisions, which only takes place when the government distorts prices). Of course, the banks are in such a moral hazard situation, knowing that the government will bail them out whenever there's a downturn. This makes it such that the banks are less interested in trying to overcome price misinformation, and are often willing partners in it.
Further, the government has screwed us over on being able to get out from under debt. Don't try to get out of either credit card or student loan debt, because it's not going to happen. Bankruptcy won't save you. And the government has made it harder and harder for the average person to declare bankruptcy, all to the benefits of the banks. This is something that has to change.
Those who have made what turned out to be bad decisions because they were lied to because of distorted prices (and, sometimes, directly), deserve justice. But the government, which is supposed to be where justice is meted out, is the culprit. Where, then, does one turn to justice?
9 comments:
I disagree with OWS movement, but you draw a two levels distinction between Washington and Wall Street hard to believe. To put it simply you are assuming *fair*economic actors almost unable to capture political power. It is more difficult but more realistic to consider the fact that economic power has a political side and viceversa. Considering always the political process as exogenous doesn’t improve our understanding of existing institutions very much.
If a democracy is moving toward a plutocracy we should consider both legal and economic incentives, causes and consequences.
Silvano
I actually make no such assumption. I agree with Adam Smith that businessmen will seek out their own benefit, at the cost of everyone else, by asking government officials to support legislation that helps them and harms everyone else. But that does not mean that the government officials have to do so. And, more, the law provides the basis for human action -- so it is still primary, while those asking for the rule changes are secondary. In this particular case, we know that banks were in fact pressured to make certain kinds of loans, and were pressured to take TARP money when they neither wanted nor needed it. I don't consider the political process exogenous -- I consider it intertwined with all the other spontaneous orders for (rarely) good and (mostly) bad. But law underlies the economy, so it's the primary cause, no matter where the ideas for their bad legislation may come from.
Ok. But how many regulators have been bankers or were connected with financial institutions? And how many bankers became regulators or policymakers? Can we ignore the fact that political power is strongly funded by financial elites? Can we ignore that banks, while responding rationally to wrong incentives, they did it assuming at least implicitly the possibility of being bailed out?
I'd like to make you notice one thing: despite interventions many banks failed or bear huge losses. But many financial managers and regulators that poorly performed escaped from the crisis very well. In a broad sense, this fact reminds me the principal-agent problem (taxpayers and shareholder lost, regulators and bankers won). But from a sociological perspective it gives me the impression that there is a network of people able to defend and reproduce its status preserving power and influence at expenses of the others. That’s why I find your division logic but a little bit ingenuous. Or better it underscores a part of the story. The roots of our problem are to be found in legislation, which is very different from law. And economic players can and do influence the legislative process. Combining Koppl with Pareto: (some) *big players* are part of the ruling elite.
Since we still have no definitive answer to the old question “qui custiodiet ipsos custodies” (and we’ll never have) and assuming that some important features of our institutions can be judged unsatisfying I think we need to consider also how “catallaxis” can degenerate. I mean that “catallaxis” is a wonderful game but it’s fragile since it can be menaced from its most successful sons. That’s why I think that Wall Street isn’t so secondary in comparison with Washington. Also from a cultural standpoint it embraced, used and sold an idea of the market order very rationalist and constructivist: for many professionals (and academicians) the Efficient Market Hypothesis represented more than a model, it has been their credo. In the battle of ideas Wall Street probably is more responsible than Washington.
Silvano Fait
I think from a scientific point of view, it makes sense to make these kinds of artificial separations to work out cause and effect. Yes, it falsifies the world to a certain degree, but it is a necessary falsification to work out what is really going on. Yes, the two -- the banking system, in this case, and the government are deeply intertwined, and have been for a long time. But consider this from the point of view of trying to get change, which is what the protests are presumably about. Can the protestors, no matter how much the protest, get the banks to change their policies? Of course not. That's not how one gets corporations to change their policies. However, protestors can get politicians to change their policies because that's precisely how the democratic order works: it is influenced by the possibility of losing votes. The protestors would do better protesting the people who will be influenced by protests. That would be the politicians, who are afraid to lose votes. The banks respond to financial incentives.
The banks are big players influencing policy. No question. But the fact that the protestors protest them gives politicians cover and even the ability to use the protestors to their own advantage -- to make more regulations that will in fact benefit the banks even more. I mean, look at how much more consolidated the banks are now than they were before 2008. Too big to fail was nothing compare to the sizes of the survivors. But if the protestors were protesting the government's involvement in all of this, the politicians won't be able to use it to their advantage. More, the numbers of protestors become a threat -- they become a big player. But only if they are protesting those who are able to be influenced by political processes like protests. Thus, my insistence that people concentrate on the role of the government -- of the legislators whose laws created the environment the banks were working in. Yes, it matters that the banks are involved, but in the end, I don't care if the banks are involved, because it is the politicians who decide whether to pass the laws or not. Unless someone wants to point out how the bankers are deeply intertwined with the politicians, and use them to get what they want, and so the politicians need to go, focusing on the banks won't accomplish anything anyone wants. No matter how intertwined the two are, the government remains the primary cause.
I think this piece by Steve Horwitz sums up what happened well.
Yes, from a scientific standpoint it makes lot of sense, but in formulating new proposals we shouldn’t forget that the analysis relies on these specific assumptions: that’s why an interdisciplinary view which combines historical, political and sociological aspects I think is very important. We may say that politics is black and economics is white, but we have to remember that there is a huge problem in the “grey area” and we need more analysis focused on it.
Truly, if protesters desire better rules and less discretion (like me and you – I suppose) they should address politicians. But I don’t think they simply want this: I think some of them want to set up a quite different agenda, more socialist and redistributionist. So, in order to change the mood of the time it is perfectly rational to capture the attention of mass media: if more voters would stand with their cause, their political influence will be greater. So until we have to deal with such people we have to figure out their way of thinking.
I partially disagree with Horwitz: his story holds well only if we neglect that in the last thirty years we had no regulatory capture in financial services industry. But mostly I don’t think his explanation is a good line of defense, for the following reasons:
In the world where we live capitalism can and do produce also crony corporatism; it’s a side effect that I dislike but to give the impression of denying it or underscoring it undermine the credibility of free market supporters. And in this moment, if free market supporters are going to be perceived like the praetorians of Wall Street Banksters there will be no chance for defending economic freedom (that’s why I think it’s important to have a workable idea of how to make big banks fail). We must play our cards well and we ought to be persuasive. Believe me: the message “the banking system is just a secondary factor because it simply reacted rationally to wrong incentives” is not so much convincing. I understand your position, but for many people it sounds like if you want to say that banks played fairly following bad ruled exogenously determined. It seems that you want to give a patent of moral legitimacy in their behavior and you want to hide revolving doors or crony corporatism practices. It doesn’t matter if it’s not your intention. It matters what the others will feel after having heard such line of defense, their subjective perception.
Silvano Fait
The protestors are all over the map in what they want. There is no consistent message. There are redistributionists, socialists, people wanting their student loans paid off, people frustrated about being unable to find work, people looking to have a good time, anarchists, libertarians protesting cronyism, etc. Most of these people are economically ignorant (I did mention there were redistributionists and socialists, after all). That needs to be addressed. But my bigger point in my original post is that nobody can expect to get justice because the one we entrusted to distribute justice is the main player -- and of course their cronies will be protected by them as well. I don't consider the Federal Reserve or Freddy or Fannie to be separate from the government in any realistic sense. The last two even less so now, though in reality they have always been government agencies. Again, there is no question that the banks wanted certain rules. And they should be held accountable as big players and secondary causes. But again, the ones who actually made the rules and enforce them (or not) should be held responsible as primary causes. But they won't -- especially if protestors are focused on the secondary players, meaning they won't get what they really want (isn't that the message of Mises: we need economics to help us understand cause and effect so that we can achieve our goals?).
I don't think Steve ignores cronyism -- that's central to his argument.
I think it is important to point out that one can act rationally to the given incentives and have bad results as a consequence. Again, that is a central message of Austrian economics. If one wants to point out that the banks were directly involved in making those rules, then by all means do point out that cronyism is involved. There is no question that it is and was. But economic incentives affect economic actors, while political incentives affect political actors. Protests are political actions, and will have no effect on economic actors. Thus, the protestor are protesting the wrong people -- no matter what their range of demands may be. I think it is irrational to argue that the politicians are corrupt, so we ought to give them more power (which is the sum position of all socialists today), but I find it even more irrational to protest people who don't even have the ability to make the changes you want them to make.
Yes, I agree with you that they are ignorant and they are protesting the wrong people. But Mises and Hayek taught me the importance of ideas (even when they are wrong or confused). In my opinion, now, they are protesting against symbols and they attracted the attention of mass media everywhere in the world. There are a lot of articles, blogs, debates about the distribution of wealth and inequalities under capitalism. In many countries other people started to imitate them. Potentially there is a fertile background for very bad ideas. Maybe protesters are simply enjoying their 15 minutes of notoriety and then we will start talking about something else. Or maybe not. In this case I think it’s important also to understand how our answers would be perceived and how can we influence the debate. There is also an education bubble. Lots of graduated people bad employed or frustrated for a long time could be really dangerous. They could be easily captured by demagogues. Our analysis should be more than scientific: it should be persuasive.
Yes, it’s stupid blaming politicians and asking big government, but it is. That’s why I think is important to have second best solutions: in my opinion there is a trade-off between economic efficiency and cronyism. Not in theory perhaps, but surely in practice. I never developed this issue very well. Mostly it’s like an intuition, a feeling. But also some libertarian friends of mine working in financial sector have the same. Probably because of this I think that your clear cut division from politic actors and economic actors underscores a part of the story. I understand it and from a scientific point of view I have no more objections. But it seems to me that now between financial sector and government there isn’t just a shadow line, indeed there is a very big and shared area. The giants of Wall Street and many influential politicians in Washington as well as many regulators are so well connected that they seem a ruling caste. Power is multifaceted.
With the Federal Reserve, banking is all but centrally planned. Certainly money is. And, thus, finance. The crisis created excuses to consolidate the banks even more -- there are far fewer now than before 2008. This is the story we need to be telling. That in banking and finance, there is only the facade of private ownership, but in fact the entire sector is almost completely controlled by the government. This is of course combined with ABCT. Cronyism resulted in the bailouts, etc. that led to further consolidation. Of course, if things get worse, or there is another crash (and there will be), a more consolidated banking and finance industry will be easier to nationalize. Why count on cronies (who may downgrade the U.S. government's credit rating), when you can control it directly yourself?
I don't think one can convince most of the people participating in Occupy. They want enforced equality -- "fairness" -- and that cannot be achieved by anyone, let alone by free markets. You don't try to convince the radicals -- you try to convince the vast middle, who can be convinced. Of course, those arguments have to be better than the Occupy crowd. And second-best solutions are often the best approach -- things that move us in the right direction, at least, and may even be better than what we have.
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