This is the fifth and final installment of my series of articles on Gary Becker, the recipient of the Swedish Central Bank’s Prize in Economics in 1992. The prior articles dealt with Becker’s work that the central bankers cited in their award decision. This article examines whether Becker, in the context of the worst financial crisis in 70 years, re-examined his views that led to his failed work on the family, women, discrimination, and crime or his colleagues’ anti-regulatory views at U. Chicago that proved so criminogenic.
More unintended self-parody by Becker: the expert on crime aids his favorite felon
It turns out that there is a remarkable event that allows us to answer this question. The event symbolizes what is so sick at U. Chicago and why we suffer from recurrent, intensifying financial crises. To understand the irony of the event it is essential to understand the critical role that “reputation” is assumed to play in U. Chicago economics. Reputation trumps all potential perverse incentives by market participants. Conflicts of interest and compensation systems that create perverse incentives to inflate reported short-term income do not lead to fraud or abuse because the officers’ concern for their reputation is paramount.
Michael Milken has created (through ample funding) two traditions that are all about his reputation. He chairs a “Nobel Roundtable” of economists at his annual “Milken Conference” which is a well-funded gathering of economists, politicians, and the formerly famous. The 2009 “Roundtable” consisted of Becker, Roger Myerson, and Myron Scholes. I have written a five-part series Myerson’s work.
Scholes is most famous for developing the Black-Scholes model for pricing certain derivatives – and for helping to blow up Long Term Capital Management (LTCM), which purportedly would have blown up a significant chunk of the financial world but for the NY Fed organizing a private bailout of LTCM. This did not lead to Scholes reexamining his belief in the fictional “efficient market.” As my columns on Myerson demonstrated, he did not reexamine his disastrous views on executive compensation as a result of the current crisis.
Michael Milken (for the young) is one of the most notorious and wholly unrepentant felons in American history. He committed a large number of felonies that made him exceptionally wealthy. So, why would Nobel Prize winners and scores of other economists, politicians, and corporate CEOs choose to associate with and lend their legitimacy to a notorious felon? Milken’s crimes involved insider trading and other forms of fraudulent manipulation that demonstrated how inefficient the markets were and how perverse executive and professional compensation systems had become. This makes the willingness of three recipients of the Swedish Central Bank’s Prize so associated with the efficient market and the terribly flawed economic analysis of crime all the more revealing and humiliating. Except that economists don’t find any of this embarrassing. They are happy to take the money of elite felons – the proceeds of their frauds – and they are happy to associate with and praise their fraudulent plutocratic patrons. The economists know that Milken’s paramount goal from these conferences is to rebrand himself from felon to Medici – patron of glitterati.
White-collar criminologists have long warned that the route to fame and reputation often lies through “control fraud.” The only reason Milken is rich and famous is because of the frauds he led. He gained his initial favorable reputation through fraud and he is very successfully purchasing a rebranded reputation with the aid of recipients of the Swedish Central Bank Prize in Economics.
Becker’s take on the crisis: no reexamination of theory or policies
Becker begins with an important rule – economists and government officials should adhere to the medical precept “first, do no harm.” Becker describes the precept as “the first principle of medicine.” This series of articles explains how Becker repeatedly violated that caution.
Becker’s Ode to Intervening on Behalf of Banks (not Humans)
Becker’s take on macroeconomics is revealing. He made the statement quoted below only seconds after Scholes had explained the unintended negative consequences of the “paradox of thrift” during a recession.
“[E]conomists have to understand that they could end up interfering with the natural recuperative powers of the economy. I’m not saying we should adopt a laissez faire attitude. I think the Federal Reserve has been right in taking a very aggressive stance in buying troubled financial assets and creating large bank reserves. But these large reserves pose an inflationary threat down the road.”
Scholes had just explained that during a serious recession the economy does not have “natural recuperative powers.” Instead, it has “natural” sickening powers that make the recession worse as demand, already seriously inadequate, falls as consumers reduce their purchases in a n effort to reduce their debt loads.
In the next sentence, however, Becker rejects a laissez faire response to the Great Recession. He loves the fact that the Fed is bailing out the systemically dangerous institutions (SDIs). Bailouts for banks, rather than people, are something Becker favors.
What is Becker’s great fear? Not the loss of 10 million American jobs and not what is now estimated as a cumulative loss of $21 trillion in U.S. GDP. Inflation is his great fear. He was speaking in March 2009, when inflation was far too low – as it was for the next five years.
But it gets worse. Becker does not mention unemployment or surging poverty as his fears. He fears democratic government.
“I’m also very worried about the stimulus package. Nobody, private or public, can spend $800 billion very efficiently. There is no free lunch here. The government is getting bigger and it will be hard to go back. That is a very real threat to the economy.”
There is no economic content to this “worr[y]” by an economist. In an economy with a GDP of roughly $16 trillion, Becker asserts that “nobody” can spend even a total of $800 billion efficiently. Should we shrink our economy by around 90% so that we can get it down to a level ($200 billion?) that we can “spend … efficiently?”
The lost demand to the Great Recession in 2009 was well over $2 trillion, so should we be overjoyed because “nobody” can spend over $2 trillion efficiently? If we have a massive loss of demand due to a Great Recession should we not have a huge stimulus program because it must be large to be most effective? Is it true that we cannot spend several hundred billion dollars efficiently on useful infrastructure projects or a jobs program to eliminate most unemployment? Is our economy made more efficient by having unsafe bridges? How exactly do unsafe bridges make our economy more efficient?
“There is no free lunch.” What does that mean? Scholes has just explained that demand is severely inadequate and that private spending, absent stimulus, would continue falling due to the paradox of thrift. They all agree that the economy is operating far below capacity. Stimulus in these circumstances is the ideal strategy. It will not lead to harmful inflation or divert scarce resources that could be used more productively in another field. Stimulus will speed the recovery, which is good for everyone. Becker does not claim that stimulus will have either of these harms. Becker’s concern is that stimulus and the public programs it funds will prove popular with the voters. He claims that when the government gets larger it inherently poses “a very real threat to the economy” – a threat that he can neither explain nor even describe. Adding “very” before “real” indicates a reliance on adjectives as substitutes for facts or even logic.
Scholes has the right metaphor for self-destructive economic policies.
“I’m wondering the extent to which economists a few decades in the future will view some of what we’ve done as the financial equivalent to using leeches.”
That is precisely the metaphor I use to describe austerity as a response to a severe recession. The idea that bleeding demand from an economy that already has inadequate demand will cause a recovery from a recession is as crazed as was the bleeding of patients. And doctor who bled a patient in this manner (anytime over the last 80 years) would have been stripped of his medical license, but there was no need to do so because doctors were professionals. Economists, however, “bleed” the economy through austerity 75 years after we learned that it was economic malpractice. The economists who continue to bleed the economy get the top Prizes in the field and set policy throughout the EU troika.
Becker’s Logic: Regulation Can’t Work Because Greenspan Refused to Regulate
Alan Greenspan, of course, shared the hate for regulation of the three economists he chose for his Roundtable. Becker, however, cites Greenspan’s refusal to regulate as his sole proof that regulation cannot succeed. Using the world’s worst anti-regulator as the proof that regulation cannot succeed evidences a droll sense of humor, intellectual dishonesty, or a testament to the power of cognitive dissonance.
Becker also provided his rule for how regulations should be drafted.
“Governments do regulation badly. That’s why I said that the regulations we already impose should operate automatically without regulatory discretion.”
Notice the flat, universal claim that regulation is always done badly. There is no basis for that claim or Becker’s earlier claim that regulation inherently fails.
“So, I’m very much puzzled when I’m told that we need additional regulation in spite of the fact that we know that regulators get caught up in the same type of optimism as market participants – that they don’t take the remedial actions that are possible without more rules. When you give a lot of discretion to regulators, experience suggests they don’t use it very well.”
The Savings and Loan Debacle and the initial rise of “liar’s” loans in 1990-1991 demonstrate that regulators do not necessarily get “caught up in the same type of optimism as market participants.” Indeed, more fundamentally, the S&L debacle proves that epidemics of the “sure thing” of accounting control fraud – not “optimism” – drive our recurrent, intensifying financial crises.
Again, more fundamentally, consider how bizarre Becker’s (non) understanding was of banking, banking regulation, and banking crises. With the benefit of the S&L debacle, Enron-era control frauds, and the triple epidemic of accounting control frauds that drove the current crisis, Becker still was literally clueless about the causes of the crises, banking, and banking regulation. Becker’s paramount policy recommendation is that regulations “operate automatically without regulatory discretion.” Here are critical real world regulations that exist or should exist.
- A bank’s minimum capital requirement should be X percent (pick your desired number).
- Banks’ reported income must be in accordance with specified accounting rules.
- Banks making home loans must verify home buyers’ reported income.
None of these rules can “operate automatically without regulatory discretion.” The principal problem in financial crises is accounting fraud. Reported capital levels and reported income can be massively inflated by accounting fraud. One of our principal functions as financial regulators is spotting such frauds. Determining compliance with rules such as loan verification requires on-site examinations. There are always some underwriting deficiencies so discretion is required both in the examination process and the supervision process. There are excellent data as to home loan defaults (as loss upon default) when we had loan underwriting rules in place compared to what happened under the three “de’s” (deregulation, desupervision, and de facto decriminalization). The discretionary regulatory regime was exceptionally effective in minimizing lenders’ losses from home lending. The deregulatory regime was so criminogenic that it produced the epidemics of accounting control fraud that brought down the entire financial system. None of the rules essential to effective financial regulation can “operate automatically.” Becker’s failure to understand the field was so fundamental that his proposed policy was nonsensical.
While Myerson Praised Criminogenic Executive Compensation
Myerson was one of the leading theorists praising the executive compensation systems that proved so criminogenic in our three modern financial crises, so it is not surprising that he praised his disastrous handiwork.
“We’re talking a lot about inequality these days in the context of CEO pay – that the benefits of financial innovation have largely gone to making a few people rich. But global prosperity depends on how well the financial community works. And, I think a successful financial system requires the possibility of bankers becoming very rich.
You can’t expect people to manage trillions of dollars of other people’s money on a clerk’s salary. It’s OK to have the inequality, but the public needs to know why it is necessary.”
Notice that Myerson ignores the perverse incentives of modern executive compensation and the resultant epidemics of devastating epidemics of accounting control fraud that drive our crises. He knows that the critique on inequality grounds is that it makes “a few people rich.” (Actually, the critique is that it makes a few thieves rich through means that destroy wealth and cause financial crises.) The obvious answer would be to show that making fraudulent bank CEOs exceptionally wealthy had made billions of people far wealthier. Myerson does not even try to make such a counter-factual showing. Instead, we are supposed to rely on Myerson’s unresponsive assertion that “global prosperity depends on how well the financial community works.” But that certainly should not be true, and if it is true it should be treated as a grave danger to the global economy that needs to be cured urgently.
Banks are simply middle men. The efficiency condition for any middle-man is that it should be lean and mean. Instead, finance has become massive and takes a grossly disproportionate share of total corporate profits. Instead of a helpmate to “Main Street” it has become its most harmful parasite. Worse, it also causes our recurrent, intensifying financial crises. But we need to focus on Myerson’s exact language: “global prosperity depends on how well the financial community works.” What proof does Myerson present that “the financial community” will “work” far better if bank CEOs can receive massive incomes by inflating short-term reported corporate earnings? None. The evidence is that such a practice harms how well the financial community works.
Myerson then stacks the deck. He asserts that “You can’t expect people to manage trillions of dollars of other people’s money on a clerk’s salary.” But why are banks handling “trillions of dollars of other people’s money?” That makes them systemically dangerous institutions (SDIs) and that means they pose an inherent global risk of the kind that just cost 10 million American jobs and over $21 trillion in lost production (and far greater losses of jobs and GDP in Europe). SDIs also make “free markets” impossible because they receive an enormous implicit governmental subsidy. They also lead to crony capitalism.
Why are there only two alternatives for a bank CEO’s compensation – “a clerk’s salary” or compensation that makes them “very rich” through the “sure thing” of leading a fraud? Surely we could have a compensation system that did not create perverse incentives to inflate short-term reported earnings and that paid bankers a salary that allowed them to send their kids to Harvard but did not make them “very rich.”
Finally, if you read my earlier series of columns on Myerson you will see the “logic” underlying his claim that “a successful financial system requires the possibility of bankers becoming very rich.” Myerson claims in his articles that the fundamental advantage that capitalism provides is extreme income inequality. He claims that CEOs have such powerful perverse to loot “their” corporations and the ability to do so with impunity that only an exceptionally wealthy CEO who is given an immense share of reported profits can be trusted not to loot the firm. That is his ode to why only capitalism succeeds – only it provides and praises the extraordinary inequality essential to ensuring the existence of a rare breed of hyper-wealthy CEOs who can be trusted not to loot their firms and destroy the capitalist system. Myerson, therefore, celebrates the most extreme forms of inequality as our greatest strength.
There is no other discipline in which the scholars who receive the top prize offered in the field could be so routinely wrong about such foundational concepts in his or her field. Milken’s “Nobel Roundtable” repeatedly used medical metaphors. Doctors who performed as badly as did these three economists would have been stripped of their medical licenses, not lionized. Only economists make errors this basic – and persist in the errors throughout lengthy careers.
One hopes that there is no other discipline that would lend the reputation of its most top Prize recipients to aid an unrepentant felon like Milken. Drexel Burnham Lambert, which Milken effectively ran though he was never its CEO, infamously ran a sexual stable of beautiful young women to service its most elite (and sleaziest) clients at the annual “Predators’ Ball” in “Bungalow 8.” The Milken Institute is a much more boring operation that offers the opportunity to be pictured with winners of the Prize in economics. Milken closed his 2006 Nobel Roundtable with these words.
MILKEN: I want to thank each of you for joining us. And Roger, you did a fabulous job in your rookie season at the Milken Institute.
Scholes and Becker were veterans of Milken’s reputational rehab institute – again proving their inability to learn from their mistakes.