Cochrane Demands that the Public Unilaterally Disarm while the Banksters Loot

By William K. Black
San Francisco, CA: November 19, 2014

(I’m participating in the annual meeting of the American Society of Criminology. I presented Wednesday on a panel honoring the 75th anniversary of Edwin Sutherland’s announcement of the concept of white-collar crime.)


John Cochrane has written an article with an initial sentence that should spark broad agreement: “confiscating wealth is ultimately about political power.” The banksters who led the frauds that caused the financial crisis “confiscate[ed]” immense wealth from the public and “their” firms’ customers, creditors, and shareholders. They did so with nearly complete impunity, which is “ultimately about political power,” indeed it defines the extraordinary nature of their power. The banksters’ confiscation of wealth has caused a dramatic increase in inequality, which has exacerbated the banksters’ domination of the levers of power. In a prior article, Cochrane stated that the financial crisis was driven by runs on financial institutions and that the runs were typically driven by elite accounting fraud.

“Not for nothing have most runs been sparked by an accounting scandal or fraud.”

Finance is the largest driver of our surging inequality. The “sure thing” of accounting control fraud has paid well for the banksters. But Cochrane ignores those data though he admits that “it could be bad inequality—crony capitalists who get rich by exploiting favors from government.” Cochrane, being an ultra-right wing economist, has no insight about what “bad” means by banksters. It means leading growing wealthy by leading the world’s most damaging three epidemics of accounting control fraud (appraisal and liar’s loan fraud plus fraudulent sales of the fraudulently originated mortgages through false “reps and warranties”). It means frauds that steal from the three groups that even conservatives agree that the banksters are supposed to aid – customers, shareholders, and creditors. It means being bailed out by the public because the bank holds hostage the global economy as a systemically dangerous institution. It also means leading the two largest financial frauds in history (Libor and FX). It means leading fraud epidemics that caused a $21 trillion loss of U.S. GDP and over 10 million American jobs. Both of those figures are far larger in Europe. In Europe, it meant banksters successfully targeting most customers for the sale of grossly inappropriate financial products.

As I quoted above, Cochrane has written previously to emphasize that accounting fraud that greatly overstates asset values is typically the driver of the runs that cause financial crises and severe unemployment. The banksters running what Cochrane concedes are accounting frauds overstate asset values in order to create the “sure thing” (Akerlof and Romer 1993) of greatly increasing their compensation and wealth. That means that the factor that is the largest single driver of surging inequality (the extreme returns – for catastrophic failure and endemic fraud – to members of the financial industry) was the underlying cause of the crisis. Cochrane, however, seems to have forgotten what he wrote about accounting fraud.

“Americans stuck in a cycle of terrible early-child experiences, substance abuse, broken families, unemployment and criminality represent a different source of inequality. Their problems have proven immune to floods of government money. *** These problems, and many like them, have nothing to do with a rise in top 1% incomes and wealth.”

No, as Cochrane admits elsewhere, the problems of unemployment and poverty have everything “to do with a rise in top 1% incomes and wealth” and the rise in unemployment caused by the fraud epidemics led by our elites is a material contributor to “substance abuse” and “broken families.”

Cochrane claims that inequality is growing because of high returns to entrepreneurs and because the “returns to skill have increased,” but the banksters provided no societally useful skill – their skill was deceit. In the UK, the banksters systematically caused what the UK’s parliamentary commission (dominated by conservatives) “dear” losses to entrepreneurs by systematically predating on them through the sale of inappropriate swaps.

If Cochrane were right, however, then there would be a vital need for government to provide the financial aid to education that once made it possible for students from poor backgrounds to go universities and build those vital skills without becoming trapped in debt for decades because government aid to higher education has been slashed.

19. The interest rate swap scandal has cost small businesses dear. Many had no concept of the instrument they were being pressured to buy. This applies to embedded swaps as much as standalone products. The response by the FSA and FCA has been inadequate.

If, as they claim, the regulators do not have the power to deal with these abuses, then it is for the Government and Parliament to ensure that the regulators have the powers they need to enable restitution to be made for this egregious mis-selling [emphasis in original].

By dramatically inflating asset values (a fact that Cochrane admits), the banksters also systematically misallocated human, physical, and financial capital. Under the models that Cochrane claims to believe, this had to materially reduce growth and “prosperity.”

Cochrane claims that inequality grows because people with math skills get high returns, but the banksters are a major problem in that specific application. Finance is the source of the huge inequality growth in people with high math skills. The banksters systematically take people with high math skills out of engineering and science – which is by far their highest and best use – and lure them into finance where they produce (in response to the perverse incentives that the banksters create) the absurd financial models that massively overstate asset values by systematically and dramatically understating risk. The result is particularly terrible because such models simultaneously increase the risk of financial crises and make people far more complacent about those risks and asset values. Had the FDIC not fought a successful rearguard action against the Fed’s and the industry’s quants on Basel II our financial crisis would have been far more severe because Basel II would have allowed far greater bank leverage.

Cochrane fails to understand the central contradiction in his concluding paragraphs.

“Cronyism results when power determines wealth. Government power inevitably invites the trade of regulatory favors for political support. We limit rent-seeking by limiting the government’s ability to hand out goodies.

So when all is said and done, the inequality warriors want the government to confiscate wealth and control incomes so that wealthy individuals cannot influence politics in directions they don’t like. Koch brothers, no. Public-employee unions, yes. This goal, at least, makes perfect logical sense. And it is truly scary.

Prosperity should be our goal. And the secrets of prosperity are simple and old-fashioned: property rights, rule of law, economic and political freedom. A limited government providing competent institutions. Confiscatory taxation and extensive government control of incomes are not on the list.”

Cochrane admits in the final paragraph that one of the “secrets of prosperity” is a well-functioning “rule of law.” He doesn’t tell you that his institution, the University of Chicago’s law, finance/business, and law faculty, have led the systematic attack for the last 40 years that successfully eviscerated that rule of law and allowed the banksters to lead the fraud epidemics that Cochrane admits drive our recurrent, intensifying financial crises. It was Judge Easterbrook and Dean Fischel who famously claimed that we financial markets were so efficient that there was no need even for a rule against fraud. Financial regulators are essential to break the Gresham’s dynamics that the banksters create that turn market forces perverse and produce what we observe repeatedly in this crisis – all of the most elite banks’ officers engaged in systematic frauds that are larger and more destructive than any in history. It is not “inevitab[e]” that financial regulation leads to crony capitalism. Our efforts as savings and loan regulators put a stake in that claim 25 years ago.

Notice several things that Cochrane ignores in his piece. First, the Koch brothers (who he implicitly lauds in his article) spend enormous amounts of money to influence public policy. When is the last time you heard that they sought to influence public policy to prosecute the banksters and ensure that we hire vigorous, effective financial regulators to break the Gresham’s dynamic? Recall that Akerlof (1970) emphasized that in addition to the customer, it is honest firms that suffer when bad ethics drive good ethics from the markets. Effective financial regulation is essential to having a well-functioning rule of law.

Second, the creation of the three “de’s” in finance (deregulation, desupervision, and de facto decriminalization) have not brought Americans “prosperity.” They have done the opposite. The vast bulk of Americans have been harmed by the three “de’s.”

Third, Cochrane doesn’t mention the folly of unilateral disarmament by the forces fighting against the banksters’ and the fraud epidemics that they lead.

“We limit rent-seeking by limiting the government’s ability to hand out goodies.”

Under Cochrane’s own logic, that cannot be true. At best, it is a dangerously incomplete claim and it is overwhelmingly a false claim. The government need not exist to have “rent-seeking.” When a bankster loots “his” bank by overstating asset values and the result is that the banksters are promptly made wealthy through the “sure thing” of accounting control fraud that leads to a run and a financial crisis, he is engaged in “rent-seeking” behavior. Indeed, under Cochrane’s own statement that an effective “rule of law” is essential to achieve “prosperity” and freedom, if the government does not exist “rent-seeking” will become a common strategy, e.g., in the libertarian and NRA paradise that is Somalia. An honest firm, appraiser, auditor, or attorney is typically helpless to protect itself from a Gresham’s dynamic generated by the banksters. Here is the Financial Crisis Inquiry Commission’s description of a bankster-generated Gresham’s dynamic that produced pervasive appraisal fraud.

“From 2000 to 2007, a coalition of appraisal organizations … delivered to Washington officials a public petition; signed by 11,000 appraisers…. [I]t charged that lenders were pressuring appraisers to place artificially high prices on properties [and] “blacklisting honest appraisers” and instead assigning business only to appraisers who would hit the desired price targets.” (FCIC: 18)

If progressives were to stop trying to get the government to create an effective rule of law, e.g., through avoiding the three “de’s,” does anyone believe that the banksters would stop trying to corrupt government? Cochrane is trying to produce unilateral disarmament by those of us who are trying to restore the rule of law that was eviscerated by the banksters’ apologists and allies at the University of Chicago. If we were foolish enough to give up our efforts the result would be a great increase in rent-seeking behavior by the banksters.

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