By Sell on News, a macro equities analyst. Cross posted from MacroBusiness
The Euro crisis appears to be developing into something similar to the 1980s Latin American debt crisis when the idea that, to quote Walter Wriston, who ran First National City/ Citibank from the 1960s into the 1980s it was assumed that: “countries don’t go out of business.” The Latin American leadership demonstrated that they, in effect, could, by defaulting. As a number of bloggers at MacroBusiness have pointed out, government finances are not like household finances, although they are often seen that way. That much is well understood in the financial community, although perhaps not as well in the wider public.
What is not acknowledged in the financial community is the assumption implicit in Wriston’s comment: that governments can be seen like a business. It is the conflation of the two that is at the heart of the growing problems in the financial system, and it is driven mainly by political prejudice. The political right, ever since Ronald Reagan, has identified government as the “problem”. A slippery piece of rhetoric because surely it is “bad government that is the problem.” But it became a carefully crafted and heavily funded message that has eventually become ubiquitous — its reductio ad absurdum is the Tea Party movement. Business good, government bad. Ergo, government should become more like business. The centre left, especially fools like Tony Blair, enthusiastically embraced the idea that government should become more like business, ending up with current day absurdities such as seeing students in the education system as “customers” (absurd because these customers, by definition, do not know what value is, unlike normal business transactions).
That is the nonsense we now live in and it is the key to why governments have abrogated their responsibility to govern in the financial system. Financial deregulation was really the ceding of governments’ responsibility to set the rules, handing it over to traders, who set their own rules. “Greedism” as Paul Krugman puts it, took over.
So, to return to the Euro crisis, viewed through a longer lens the current instability is related to this conflation of government and business, the emergence of what Phillip Bobbitt in “The Shield of Achilles” calls the “market state”. The Economist described the Euro’s travails thus:
An alternative diagnosis explains the continuing chaos by pointing out that an implicit assumption behind Europe’s financial integration—that sovereign debt was risk-free—has been overturned, and no one knows what to assume instead.
The euro project was founded on a rule that there would be “no bail-outs” of governments’ debt. But, as an analysis by Peter Boone and Simon Johnson of the Peterson Institute points out, its financial plumbing developed in a way that suggested the opposite. Initially the ECB treated all sovereign bonds equally. Even when it decided to take credit ratings into account, the ECB’s practices discouraged banks from clear distinctions between sovereign bonds.
Yes, we are back with Wriston’s “governments don’t go out of business”. But of course, they are not in business, ever. And they can become insolvent.
My suspicion is that we are at a turning point in this long period of a priori demonisation of government. It is true that the anti-government argument was not without its merits, especially when seen in historical context of high levels of state control. Having no government is often better than bad government. Legislation and regulation is frequently counter productive. Incentives in private organisations are often clearer than in public organisations, lending the former a certain efficiency, at least some of the time (although, as we have seen, these private incentive methods can be easily corrupted).
The problem was the exaggeration. Business is not essentially “good”, nor government “bad”. For one thing, businesses routinely fail to last. Governments must last. In an area like infrastructure, which needs to last many decades, using businesses, most of which will fail in under ten years, is asking for trouble.
The malign effects of the exaggeration become most obvious in the financial system, where governments must govern. Finance is rules, governments must rule. But the rulers have left the building and those who should be ruled, the private players, have been allowed to set their own rules. Krugman and Robin Wells, in a review of a book “Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present, by Jeff Madrick” (Knopf) describe how Milton Friedman popularised the anti-government mantra:
In Friedman’s worldview, free markets were the solution to practically every problem – health care, product safety, bank regulation, financial speculation and so on. And Friedman squarely blamed government for the Great Depression, a view that is at odds with the data. (Although it is almost certainly true that mistakes by the Fed made the situation worse.) As Madrick quotes him, “The Great Depression, like most other periods of severe unemployment, was produced by government management rather than by inherent instability of the private economy.” Replace “Great Depression” with “the financial crisis and its aftermath,” and it could be US house of representatives speaker, John Boehner, today, rather than Friedman in 1962, speaking these words. Like Reagan, Friedman proclaimed a creed of greedism (our term) – that unchecked self-interest furthers the common good.
That is the problem, Krugman and Wells ask why it was allowed to occur:
There are a lot of villains in this story – so many that by the end of the book we were, frankly, suffering from a bit of outrage fatigue. But why have villains triumphed so repeatedly?
The proximate answer, clearly, is the abdication of regulatory oversight. From junk bonds to derivatives to sub-prime mortgages, regulators either turned a blind eye or were impeded by business interests and politicians – Democrat as well as Republican. Undoubtedly the most outrageous act – and the most economically damaging to the country – was Greenspan’s refusal to use regulatory powers at his disposal to rein in the exploding subprime market, despite being warned repeatedly that a catastrophe was brewing. Like Reagan and Friedman, Greenspan firmly believed in greedism; in his view, the financial markets could do no wrong.
Yet if the problem was lack of oversight, that leads to another question: Why did the regulators abdicate – and keep abdicating despite repeated financial disasters? This is perhaps the most frustrating aspect of Madrick’s otherwise excellent book: we get a lot of the what, but not much of the why. Madrick’s character-centred narrative makes it seem as if the triumph of greed was the result of a series of contingent events: the inflation of the 1970s, the exploitation of that inflation by Reagan and Friedman, the wheeling and dealing of the likes of Sandy Weill, and the diffidence of Jimmy Carter and Bill Clinton. Yet surely there must have been deeper forces at work.
Krugman and Wells go for a political explanation, for which there may be some merit, although one senses it is a bit irrelevant:
We have argued elsewhere (and are not unique in doing so) that white backlash – especially Southern white backlash – against the civil rights movement transformed American politics, creating the opportunity for a major push to undermine the New Deal. Also, it’s hard to make sense of the growing ability of bankers to get the rules rewritten in their favour without talking about the role of money in politics, and how that role has metastasised over the past 30 years. There’s another book to be written here – perhaps less personality-centred and hence less entertaining than Madrick’s, but one that gets at the forces that made the reign of financial villains possible.
Whatever the deeper story, however, Madrick’s subtitle gets it right: what we have experienced is, in a very real sense, the triumph of Wall Street and the decline of America. Despite what some academics (primarily in business schools) claimed, the vast sums of money channelled through Wall Street did not improve America’s productive capacity by “efficiently allocating capital to its best use”. Instead, it diminished the country’s productivity by directing capital on the basis of financial chicanery, outrageous compensation packages and bubble-infected stock price valuations.
My suspicion is that it has mainly been intellectual fashion, fanned with the backing of any number of corporate backed think tanks spewing out “research” that was anything but real research; rather pro-business propaganda. A sort of flat earthism, helped by some unsavoury support from those who benefit the most. But in the end its supreme illogic is catching up with it. When the contradictions of greedism only affected peripheral economies, such as Latin America and Asia, then those “other countries” could safely be blamed. But now it is affecting the major developed economies of Europe and the US, and it is becoming harder to avoid the obvious conclusion. It is not a choice between no government or bad government. It is a choice between bad government or good government.