It’s the 21st Century, Stupid!

David Brooks writes of the recent problems in the financial sector of which the subprime mortgage mess is only one part. His column says that there are two narratives and only two narratives used to explain it. The Greed Narrative or the Ecology Narrative. He closes with this (emphasis mine).

The lesson of the Ecology Narrative is that, in most cases, the market corrects itself. Maybe this year banks will change their pay structure so there’s not so much emphasis on short-term results. Maybe companies will change their boards to improve scrutiny over complex new instruments. In short, markets adapt.

People who embrace the Ecology Narrative don’t like the offensive bonuses that get handed out on Wall Street. They just don’t see any way the government can curtail them without rending the fabric of the ecosystem. They don’t like the periodic crises, but don’t see how government can prevent them without clamping down on innovation. The challenge is to give people the means to withstand the perturbations.

The Ecology Narrative is not morally satisfying. I wouldn’t bet on its popularity as a backlash against Wall Street and finance sweeps across a recession-haunted country. But the Ecology Narrative has one thing going for it. It happens to be true.

I just haven’t seen any signs that there is anything in the financial services sector that would correct the problems with the compensation structure. I haven’t read anything anywhere that indicates I’ve missed something that would indicate there’s any demand building for a system less destructive of the long term good. After all, the people who make a mint with the current structure are the ones in charge and there is no motivation for them to change things and the incestuous relationship between company management and boards pretty much guarantees there is no force influencing them from the “outside” to encourage repairs. There is no magic wand, spell or potion that guarantees that “markets adapt”. Not so long as over-compensated executives and traders have people like Brooks shrugging and saying that they and the damage they do to our economy must be tolerated because of unproven claims about the good they do.

But his claim is too simple. His last sentence precludes the possibility that while the Ecology Narrative has a lot going for it, it just doesn’t explain a lot of what is seen in the real world. Frankly, Mr. Brooks, someone got a lot of their Greed Narrative in your Ecology Narrative. And the narrative that includes them both is the one that is true.

Do you think that any of the hotshots on Wall Street are familiar with Pogo? Maybe you remember the famous saying and maybe you don’t but Wall Street seems to be the latest capitalists to have become capitalism’s greatest enemies. I rarely agree with anything Robert J. Samuelson has to say but this column of his actually makes some sense. But of course, since it is critical of the current economic environment he just dips his toe into the water. He rightly points out that the compensation structure not only produces incredulity on the part of many that these people really deserve the huge pay packages they routinely get but also encourage behavior that has larger consequences for the country. The way their bonuses are structured encourage activities that have little to do with what’s good for their customers, the companies whos stocks and bonds they sell and certainly not what’s good for the average person who doesn’t work for them.

Consider this admission from someone who should know:

“People self-select for careers. On Wall Street, they self-select for the money,” says pay consultant Alan Johnson. “Wall Street is a sales business — they sell bonds, securities, transactions, ideas. . . . They’re not paid to be long-term, philosophical, reflective.” The pressure is to do the next merger, sell more stocks and bonds, do more trading — whatever boosts current profits and bonuses, the long-term consequences be damned.

The focus is an unrelenting one purely on personal gain and status in the company that accompanies doing well in the short term measurements that are pretty much all they deal in. The standard excuses are that they are responsible for the strength of our economy by their ability to provide capital to those companies that deserve it. But Samuelson points out the places where they have failed miserably at this task. I think that he could have listed more but after all, there’s only so much room for his column and so much time to research it, isn’t there?

Samuelson closes with this:

But if the subprime failure turns out to be a preamble to a larger financial breakdown, flowing from the creation of new securities that offered short-term trading possibilities but whose long-run risks were underestimated, then the mood could turn uglier. Indeed, many Americans may conclude that capitalism has run amok.

But let’s be honest, this current disaster in the making is related in a very basic way to Enron, Enron and other energy trading companies’ gaming of the California energy market a few years back, Tyco, Global Crossing, Adelphia, Arthur Andersen, Worldcom and the rest. It relates to the demands placed on publicly held companies by Wall Street. There is no restraint, no moderation. There doesn’t seem to be any such thing as enough. There isn’t enough profit to make them happy, there isn’t enough income to give traders and consultants the ego boost, status and material goodies they apparently crave. So eventually it becomes just too easy to step over the lines, whether they are the ones separating honesty from dishonesty or ambition from greed. Just remember that the very definition of greed includes the word excessive. MBA programs now include more discussion of ethics than before the wave of scandals that swept American business a few years ago. But how many of them ever address the simple idea that at some point people in business should say “Enough. That’s going too far.”. Because even if it’s legal that doesn’t mean it’s a good idea.

Brad DeLong points out a couple of articles that speak of the reality of tax cuts and that the Republican claims that they always produce more revenue, currently being pushed extra hard by Rudy Giuliani, just aren’t true. None of what they say is really hard to understand and it makes a lot of sense. What does it say about the politicians who refuse to acknowledge the blindingly obvious? Nothing positive. Nothing positive at all.

The New York Times titles its article Ending Famine, Simply by Ignoring the Experts. And it’s right. Those donor countries who relied on the blind belief in free markets that is currently the fashion in many developed countries and the World Bank were wrong and the new president of Malawi was right. Subsidies for poverty stricken farmers to be able to have seed and fertilizer was necessary for them to produce their own food and should probably be expanded to other countries with similar situations. The free market has little to do with farmers whose current production isn’t even enough to allow them to feed themselves.

So can we arrange for the Economics School of the University of Chicago to lose its government funding since we shouldn’t be subsidizing religion even if it’s the First Church of Free Market?

Why does anyone believe anything that George W. Bush or anyone who represents him or allies themselves with him says anymore? Remember the good old days when he was saying that he hadn’t made up his mind about going to war with Iraq?  And that thinking that it might cost $50 billion was dismissed as speculation? When Mitch Daniels said that Larry Lindsey’s estimate of $200 billion was the upper end of a hypothetical?

Now there are estimates that the combined total of Iraq and Afghanistan could reach $2.4 trillion before it’s all said and done. What’s the White House reaction?

The Bush administration has declined to make long-term projections because “the war is ever-changing” and costs are difficult to predict, said Sean Kevelighan, press secretary for the White House budget office.

“Congress got a predictable answer to its leading question, which was clearly intended to artificially inflate war costs (by) politicians in Washington trying to manage our military commanders,” Kevelighan said.

“Budgets follow military decisions, not vice versa,” he said.

What do Bush’s allies in the Republican Party have to say about it?

Rep. Paul Ryan of Wisconsin, the ranking Republican on the committee, said the estimates fail to show that as a percentage of gross domestic product, the nation is better equipped to pay for these conflicts than previous wars.

Of course I want to know what the percentage of GDP has to do with it? Government revenues and debt are what matter if you’re going to discuss an enterprise that the government is paying for and these same people want Bush’s tax cuts to stay the course. They want the estate tax eliminated. Many of them want capital gains taxes eliminated or at least reduced even further than where they are already at. Look at these numbers and realize that President Bush is once again threatening to veto SCHIP, claiming that part of the reason is the expense, $35 billion over 5 years.

As I said to begin this post, why does anyone still believe this man or his minions?

David Broder writes about a plan to fix our health care problems with a “publicly subsidized individual health insurance”. Of course this concept is somewhat useless. OK, it’s lots of “thought” about a proposal that will do nothing to help improve our system. Why won’t it? The key lies in this paragraph.

Instead, the report calls on government to restructure the private insurance market in less rigid form than Hillary Clinton proposed 14 years ago — and then step back and let competitive market forces do their invaluable work of forcing recalcitrant insurers, doctors and hospitals to bid against each other on the basis of price and quality.

Competitive market forces do not simply function magically in a vacuum. The primary concept behind the ability of the market to accomplish what these people expect it to is the rational choice theory, which is also used in other social sciences. Rational choice in turn relies on a rational actor. The assumption of the existence of a rational actor is one where the people taking part in the economy are willing and able to make a choice based purely on their knowledge of their needs, the product being purchased and their ability to pay for it. It does not account for irrational fears, emotions or choices based on incomplete information or lack of understanding. The plain truth is that the vast majority of the American populace does not have any information base for making these choices and the plans that hope to use the magic of the free markets do not address that fact. There are economists and social scientists addressing the limitations of this part of neoclassical economic theory, as shown by this article in Harvard Magazine but apparently those who are proposing that the market will solve the problems in the American health care system don’t acknowledge them. They also don’t acknowledge the desire of those in the health care industry to distort rational choice with advertising, small print, legalese and the ability to in effect change the terms of any agreement unilaterally much as their compatriots in other industries do. Look at this article from SmartMoney and realize that those who propose that the current system, largely unchanged, is what we need to stick with believe it is perfectly acceptable that consumers go through this routine. I disagree.

If you read blogs and hear the views of American political conservatives it’s hard to miss the philosophy that says that government should be limited and in the more extreme positions doesn’t believe in government social programs at all. This ideology says that people can and should take care of themselves. If something happens and they really do need help then private charities can and should be the ones to help. It derives from the refusal of these ideologues to consider government to be a worthwhile representative of the wish of the people to help their fellow countrymen. The idea is that the only people who can really decide the best way to help others are those who have the money. They might not phrase it so indelicately but that is what it comes down to. Keep the government out of it and as small as possible. But there’s at least one problem with this idea and it isn’t a little one.

The New York Times business section reports on the big charitable donations made by the wealthy in the U.S. Yes, some of the billionaires and multi-millionaires among us are donating very large amounts of money to charities. Well, they’re donating to organizations that earn the label of charity and give those who donate to them the appropriate tax deductions. They are worthwhile organizations of all kinds representing many worthwhile goals and endeavors. But the one thing that must not be forgotten when you hear the arguments concerning private charities taking care of the needy in the United States is that little of the charitable giving done by the wealthy goes to that kind of relief. It goes overseas to people who need it desperately, it goes to scholarship funds, it goes to worthwhile medical research, it goes to universities, it goes to libraries, it goes to symphonies, it goes to museums and it goes to other worthwhile groups and institutions. But not to the people in this country who need help.

Consider this from the article:

Roughly three-quarters of charitable gifts of $50 million and more from 2002 through March 31 went to universities, private foundations, hospitals and art museums, according to the Center on Philanthropy at Indiana University.

Of the rest, the Bill and Melinda Gates Foundation accounted for half on the center’s list. That money went primarily to improve the lives of the poor in developing countries. Valuable as that may be, it also meant that the American public effectively underwrote several billion dollars worth of foreign aid by private individuals, even though poll after poll shows Americans are at best ambivalent about using tax dollars in such assistance.

In contrast, few gifts of that size are made to organizations like the Salvation Army, Habitat for Humanity and America’s Second Harvest, whose main goals are to help the poor in this country. Research shows that less than 10 percent of the money Americans give to charity addresses basic human needs, like sheltering the homeless, feeding the hungry and caring for the indigent sick, and that the wealthiest typically devote an even smaller portion of their giving to such causes than everyone else.

The emphasis is mine. Yes, less than 10% of money donated to charities in this country overall, not just counting the donations from the wealthy, go to the immediate needs of the less well off among our own countrymen. Is it really the belief of this brand of conservative that somehow should they succeed in eliminating the government programs they would like to see go away that this would magically change? Do they believe that we would somehow discover the magic key that would allow a capitalist system to provide 100% employment with all the jobs being good enough to put a roof over everyone’s head and keep food on the table for the least well paid among us? Is there any real proof to back up these kinds of beliefs? I have yet to see anything but blind faith in the power of the free market to solve problems being cited to back it up. And that’s not a faith I find particularly comforting.

Robert Reich posts on his blog about moral hazard and what it really means to those who consider themselves conservative in these modern times. The long and short of it is that the people with influence, wealth and political clout get bailed out. When’s the last time you heard of a CEO who had failed the stockholders and employees of a company who didn’t leave with a healthy payoff? But now, when there are who knows how many people in danger of losing their homes and what little credit worthiness they had because of their purchase of a home by using a sub-prime mortgage moral hazard is among those things cited as someone who should pay the price because they knew that they couldn’t possibly afford the variable rate mortgage they were signing up for. But did they, really? After all the people signing them up weren’t simply presenting them with paperwork that was clear and understandable. There were salespeople involved. Salespeople who made more money if the people they were selling to spent more and went deeper into debt. Salespeople who are very good at making people feel optimism about their financial future, no matter how misplaced it might be.

And there are of course other arenas in which moral hazard is used to support the desires of modern “conservatives”. We can’t have useful unemployment benefits, can we? After all, those lazy bums that work for the executives who must be bailed out wouldn’t go find another job right away if you actually had an unemployment program that they all qualified for and that would keep them from losing their homes. Then there’s health care. If we don’t make certain that individuals feel some financial pain from it they’d be running off to the doctor at the drop of a hat. Their arguments about health care and how it should be left to the market never ever address the not uncommon enough situation where someone works hard, pays for their health insurance and after becoming seriously ill lose that insurance.

In other words the modern version of moral hazard is morally hazardous for a decent nation.

That’s what David Ignatius writes about in the Washington Post. What it comes down to is a variation on my criticism of what motivates much of the current American business world. It’s not enough to make a profit. There’s never enough profit, apparently. The search is always on for a greater margin or rate of return no matter how risky or how questionable it might be for the long term good of the company or our society. It doesn’t matter what happens to those thousands of people you fire from their jobs so that Wall Street will approve of you enough to up the stock value and the incomes of those executives who receive a significant part of their income from stock options. There is no other value that matters. Now keep in mind that many would have this environment and set of values determine everything about our health care system.

Is there anyone who wasn’t in on doing stupid stuff in the housing market? In our most recent run-up the builders became lenders and BusinessWeek Online through MSNBC reports that it isn’t a good thing.