financial services s&l guarantee debt moral hazard

Replace Guarantees With What?
ceo government interference

Do Bailouts Lead to More Bailouts?

What if, instead of a surprising one-time disaster, this outcome was routine and predictable, given present politics that creates, as they daintily say, "moral hazard" for insiders. What would create moral safety then? The writer's latest book, Be the Solution: How Entrepreneurs and Conscious Capitalists Can Solve All the World's Problems, is with John Mackey, Muhammad Yunus, Hernando de Soto, and others.

by Michael Strong, FLOW, Inc, 3 June 2010

"In this crisis, average Americans have sent hundreds of billions of dollars to some of the richest people in human history." -- Russ Roberts, "Gambling with Other People's Money"

A few hundred individuals in the financial services, individuals who might otherwise have been worth tens of millions of dollars, managed instead to get their hands on hundreds of millions of dollars. Now we are all suffering higher taxes, higher unemployment, fewer new business starts, tighter capital markets, and lower rates of charitable giving so that a few hundred individuals can buy larger islands and bigger yachts. It is a disgusting sight, inconsistent with all moral codes and political philosophies.

What if, instead of a surprising one-time disaster, this outcome was a predictable and routine outcome of our political process?

Paul Romer and Nobel laureate George Akerlof published an analysis of the S&L crisis of the 1980s titled "Looting: The Economic Underworld of Bankruptcy for Profit" which analyzed how some wealthy executives extracted tremendous sums of money from the S&Ls that they "led" while knowing that their decisions would lead the companies to bankruptcy. Romer and Akerlof conclude: "Bankruptcy for profit occurs most commonly when a government guarantees a firm's debt obligations."

This 1993 article was widely published . Yet the US government not only continued to guarantee debt obligations but also expanded them by actions supported by both major parties.

And bankruptcy for profit is the most extreme case of moral hazard due to government guarantees; there are plenty of deep moral hazard issues due to government guarantees that could lead to similarly catastrophic outcomes well before we get to the case of outright looters.

Akerlof and Romer: "When regulators hid the extent of the true problem with artificial accounting devices, when congressmen pressured regulators to go easy on favored constituents and political donors, when the largest brokerage firms lobbied to protect their ability to funnel brokered deposits to any thrift in the country, when the lobbyists for the savings and loan industry adopted the strategy of postponing action until industry difficulties were so large that general tax revenue would have to be used to address problems instead of revenue raised from taxes on successful firms in the industry, people responded rationally to the incentives they faced within the political process."

“If we learn from experience, history need not repeat itself." Yet here we are, twenty years later, with a much larger and more damaging catastrophe.

In an interview, Freddie Mac’s former chief risk officer, David A. Andrukonis, recalled telling Mr. Syron, the Freddie Mac CEO, in mid-2004 that the company was buying bad loans that “would likely pose an enormous financial and reputational risk to the company and the country.” He was let go.

Arnold Kling, Russ Roberts, and other economists are pointing to government guarantees as the essential problem that must be removed in order to prevent a similar recurrence of financial catastrophe.

Ron Paul promoted such a policy move in 2003: “Today, I will introduce the Free Housing Market Enhancement Act, which removes government subsidies from the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the National Home Loan Bank Board... Congress should act to remove taxpayer support from the housing GSEs before the bubble bursts and taxpayers are once again forced to bail out investors who were misled by foolish government interference in the market.”

Had Paul's proposed bill been passed into law, financiers would be having to get along with merely tens of millions rather than hundreds of millions of dollars.

Do we have to wait another twenty years, provide a few thousand more of the richest people in history with more islands and yachts with our tax dollars, and watch the US itself go bankrupt before we take these issues seriously?

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JJS: Actually, the wait is on average 18 years. And if we can craft our message just right, and broadcast it just right, then no, we won’t have to wait. Not if the message inspires people to adopt geonomics.

If government were to lose most of its discretionary power to spend public revenue, but instead had to pay citizens a dividend from recovered “rents” -- all the money we spend for the nature we use -- then politicians would not have the wherewithal to spend on their donors, insiders would not have the wherewithal to donate to elected officials, and the citizens getting dividends would hardly choose to fund any such enrichment schemes for the elite.

The key to this geonomic reform is the Citizens Dividend in lieu of subsidies, supported by rent recovery (via taxes, fees, leases, dues, etc) in lieu of taxes on earnings, sales, and buildings. It’s the CitDiv that focuses public attention on the issue of who should have the power to spend the commonwealth, the economic values that we all generate and all of us are entitled to. How do we stop this periodic looting of the Treasury? Pay the CD; redirect the funds to us all.


Editor Jeffery J. Smith runs the Forum on Geonomics.

Also see:

Even when the native expert says it, we don't hear it

Big Name Profs Spout Ideas -- Would They Work?

Why Animal Spirits Matter for Global Capitalism

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