By William K. Black
(Cross-posted from Benzinga.com)
This column was prompted by listening to Mark Steyn (an ultra right writer) giving a C-SPAN talk on his new book that asserts that America has destroyed itself and will be superseded soon by China. Steyn is best known for his fear of a Muslim takeover of Europe. (During the C-SPAN talk he warned that the “Mullahs of Dearborn” had created “Michiganistan.” I grew up in Dearborn, Michigan, so perhaps I am agent of this dread conspiracy that has subjugated one of our states – and cleverly disguised its takeover by radical Islamic agents by electing conservative Republicans to run the state.)
Steyn’s contradictory concerns are that the United States government borrows too much money and spends too little on the military and too much on education. (He opines that university educations are a “waste” for “most” college students. Again, I may be an agent of this evil conspiracy to educate our kids.) He was a strong supporter of our recent invasions. He expressed his distress that the U.S. military was not leading the war in Libya. Under Steyn’s view of how financial systems work, those invasions were financed primarily by issuing large amounts of debt and were major contributors to what he terms a “debt catastrophe.” Indeed, he emphasizes his support for the massive amount of money that the U.S. spends on its military even when we are not a war – roughly the same amount as the rest of the world combined. He also claims that Western Europe is able to fund its generous social programs because they are “free riders” on the U.S. military. In other words, he argues that military spending limits U.S. growth and increases Treasury debt – and we should expand our spending and our invasions. His views are logically incoherent.
Steyn claims that he is most concerned about “wealth that is not yet created.” That is an excellent concern, one that competent economists stress. It is a concern that has virtually disappeared, however, in the context of the budget deficit games. We have roughly 25 million Americans that want to work full time but cannot do so because of the Great Recession. Their potential productivity is the quintessential example of “wealth that is not yet created” – the thing Steyn purports to find most distressing. Keeping twenty-five million Americans who want to work full time unemployed and underemployed constitutes the definition of “waste” and the gratuitous destruction of “wealth that has not yet created.” The waste and destruction of wealth are pointless – there is no benefit. The waste and damage are far broader than economic. Unemployment damages people, particularly adults, and communities. We can end all but a small residual of transitional unemployment any time we choose to do so. Doing so would shorten the Great Recession and greatly reduce its damage.
It is deficit hawks like Steyn, however, that keep us from creating the “wealth that is not yet created.” Steyn can’t understand that the primary reason that the deficit rose sharply was because of the Great Recession. Steyn is so unaware of economic theory that he wants the U.S. to adopt pro-cyclical policies that would have made the Great Recession far worse. He also thinks that governments with sovereign currencies are just like households when it comes to their debt. Worse, he thinks budget deficits are “moral” issues rather than financial issues. “It’s not a spending crisis, it’s a moral one.” “We are looting the future to bribe the present.”
There is a moral component to this crisis and “looting” is the key. George Akerlof and Paul Romer captured the component in the title of their famous 1993 article (“Looting: the Economic Underworld of Bankruptcy for Profit”). There are real looters out there, running many of our largest financial institutions. Their frauds hyper-inflated the financial bubble and drove the Great Recession. Running a deficit in a recession is not “looting.” Balancing a budget during a recession is insanely pro-cyclical. In 1937, when President Roosevelt made the grave mistake of listening to his conservative economic advisors and tried to balance the budget the policy through the U.S. back into the worst of the Great Depression.
Steyn is correct that the core of the real moral crisis is that we are “… absolving the citizenry for responsibility from their actions.” The citizens we are absolving are the perpetrators of the looting. The CEOs running the “control frauds” are not being prosecuted. They simultaneously caused catastrophic losses and profited enormously from their frauds (“bankruptcy for profit”). Steyn explicitly warns about the damage that elite frauds do to a nation, stressing “the fragility of civilization.” He claimed that the U.S. was about to become a Latin American nation entrenched in crony capitalism characterized by a wealthy, corrupt elite and vast numbers of the poor. He is correct that this crisis both represents and causes “the diversion of too much human capital into wasteful and self-indulgent activity.” The CEOs that run control frauds cause enormous, inefficient diversion of capital to the least productive investments and do so for the most self-indulgent reasons and in the most indulgent manner. They gloried in their toys, the private jets and many luxury cars. In a nation with a grave shortage of citizens with expertise in mathematics and the hard sciences we took many of our top graduates and made them financial “quants.” The quants, acting in accordance with the perverse financial incentives that the senior officers created, destroyed wealth. The full opportunity cost of diverting quantitative experts from science to aiding fraudulent finance includes the scientific research opportunities foregone. Steyn claims that college is a “waste” for “most” people who attend, but I’m one of the millions who are alive because of health research by university-trained scientists.
Steyn, however, is again a major part of the problem. He is notorious for his defense of the CEOs found guilty of running control frauds, i.e., his friend and fellow Canadian Conrad Black (no relation to me). Rather than holding these elite frauds accountable, Steyn is one of the leaders in the effort to allow them to loot with impunity. As Akerlof explained in his classic 1970 article on a market for “lemons,” fraud can create a “Gresham’s” dynamic in which markets become powerfully perverse. When frauds prosper, bad ethics drives good ethics from the marketplace. It is imperative that regulators serve as the regulatory “cops on the beat” to ensure that the frauds do not prosper and prevent economic catastrophe. Steyn is a virulent opponent of effective financial regulation. In his talk, he expressed no concern over the fraudulent elites extracting billions of dollars in wealth from creditors and shareholders. His rage was addressed to schoolteachers. Ignoring the trade-off they made between receiving lower salaries but superior pensions, Steyn focuses solely on the pensions received by public workers and claims that they are outrageous. He does not explain why his outrage is reserved for the little people, and only for the one portion of their compensation that is not sub-market.
The U.S. followed Steyn’s anti-regulatory policies for years, creating the criminogenic environment that produced our recurrent, intensifying financial crises. The three “de’s” – deregulation, desupervision, and de facto decriminalization – that led to the current crisis disappear in Steyn’s telling of the tale. Instead, he claims: “We see an unprecedented transfer of resources from the productive class to the obstructive class – to government, to regulators, to bureaucracies.” “We are redistributing liberty.” “Law has been supplanted by regulation.” Many of the regulators are “to the left of either party.” They U.S. is engaged in unprecedented, “hyper-regulatory direct rule….”
The reality is that the financial regulatory agencies, for decades, have been led overwhelmingly by conservative business people who are reflexively opposed to regulation. There are exceptions, but Steyn is correct that our financial policies are “rule[d] by a monopoly of ideas.” That monopoly is the opposite of the one Steyn fears – it is the neoclassical economics and modern finance idea that markets are efficient and automatically exclude fraud and that regulation is therefore unnecessary and harmful.
Steyn appears to assume, contrary to fact, that the CEOs of the financial firms are the “productive class.” He contrasts them to President Obama: “We entrusted a multi-trillion dollar enterprise to a guy who has never created a dime of wealth in his life and then we were surprised that for some reason it did not work out.” Let’s recall reality. We entrusted the U.S. government to President Bush. As a serial failure as an oil executive, our nation’s first MBA president destroyed wealth. He was repeatedly bailed out and ultimately made wealthy by political opportunists. As President, he destroyed staggering amounts of wealth and life. The CEOs of the nonprime lenders and investors destroyed massive amounts of wealth (roughly $10 trillion) – and were made personally wealthy because they did so.
But for the bailout by the U.S. government, the financial system would have collapsed. Steyn praised Americans as unique. Nearly all other Western nations experienced major protests demanding that the government take on the elite bankers, but in the U.S. the Tea Party protests were funded by the most conservative business factions and the protests demanded that the government adopt those factions’ anti-regulatory agenda. Steyn claimed that the Tea Party message was that they would be just fine if only the government were to do nothing in response to the crisis. That message is false as a matter of economics. Only the government was able to protect the Tea Party members from alling into a depression. Individuals cannot protect themselves effectively from a Great Depression or a Great Recession.
Steyn concluded his substantive argument with these words.
“I quote Milton Friedman: ‘don’t elect the right people to do the right things, create the conditions whereby the wrong people are forced to do the right things. There should be nothing controversial [about that statement].’”
What Steyn fails to understand is that Friedman’s point refutes Steyn’s anti-regulatory thesis. Friedman was simply making the fundamental point of economics – focus on the incentives and ensure that they are (1) powerful and (2) prevent perverse behavior. Control fraud both arises from and causes intense, perverse incentives. Fraud begets fraud. Accounting control frauds deliberately create perverse Gresham’s dynamic to spur fraud within their product line and create criminogenic environments that produce “echo” fraud epidemics in related fields. The CEOs of the lenders that specialized in making fraudulent nonprime loans, for example, used their ability to hire, fire, and compensate to create these perverse incentives among appraisers, loan brokers, loan officers, and credit rating agencies. Note that this allowed the fraudulent CEOs to suborn “controls” into their most valuable fraud allies and created deniability while making it more difficult to prove the CEO’s intent to defraud.
Once more, Steyn is a leading critic of the reforms that are essential under Steyn’s logic to prevent these crises. A Gresham’s dynamic can cause good people to do the wrong things. Vigorous financial regulators who serve as the regulatory “cops on the beat” are essential to the creation of the proper incentives so that the wrong CEOs are forced to do the right things.
Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.
Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.