Thursday, March 27, 2008

Prerogative power and the death of "free markets"

Remember Friday March 14 2008: it was the day the dream of global free-market capitalism died. For three decades we have moved towards market-driven financial systems. By its decision to rescue Bear Stearns, the Federal Reserve ... declared this era over. ... Deregulation has reached its limits. - Martin Wolf, FT

Martin Wolf makes, I believe, an important point in declaring the death of "free market" capitalism (although I would have added, "for this cycle" and good riddance). To the extent financial institutions become dependent on government for survival, using the same arguments which justify intrusions into the lives of welfare recipients, these institutions should be regulated by the government.

Robert Rubin, one of the prominent supporters of financial deregulation during the Clinton years has, according to Paul Krugman, "seen the light:" If Wall Street companies can count on being rescued like banks, then they need to be regulated like banks.

Not to be outdone by one of his predecessors, current Treasury Secretary, Hank Paulson, joined the chorus yesterday: Historically, commercial banks have had regular access to the discount window. Access to the Federal Reserve's liquidity facilities traditionally has been accompanied by strong prudential oversight of depository institutions, which also has included consolidated supervision where appropriate. Certainly any regular access to the discount window should involve the same type of regulation and supervision.

This approach- using the might of the state to effect change- is in keeping with the Bush administration's philosophy- the state is not a reflection of the mood of the times, it creates the mood.

If it were only so easy.

For, as Mark Thoma notes at Economists' View in An Absence of Oversight: As the philosophy of both parties has drifted toward a hands off approach over time, and as appointment after appointment to this or that agency has reflected that changing philosophy, the accompanying regulatory oversight has changed along with it. The changes have been more dramatic under Republican administrations, and the current administration strongly prefers a hands off approach on all matters involving economic policy (with the exception of tax cuts for the wealthy), so it's no surprise that the same philosophy has, over the last several years, filtered into the offices charged with regulatory oversight more so than in the past (and appointments based upon how much someone contributed and the strength of their ideology rather than their competence hasn't helped). To change all of this and reign in the excesses, it will take more than just changing the rules, it will also be necessary to change the people interpreting and enforcing the rules,

I wouldn't go as far as Mr. Thoma in urging that people go, but rather, and more simply, that they change their views.

Unfortunately, such changes often require a peek into the abyss, so to write, particularly when many have been indoctrinated into an unfeasible point of view . "Too big to fail" has no place in free market ideology.

Just as the right wing, justifiably in my view, bemoaned the middle of the 20th Century Marxist shift in leading Universities- the preaching of the virtues of communism, as if the problem was the "ism" rather than the views of the people in charge, so too will we regret the more recent embrace of the free market philosophy to which Mr. Thoma refers.

Am I, you might be wondering, against "free markets?"

No, my issue lies in the definition thereof. The current conception of "free markets," it seems to me, borrows more from the New Deal view that the state should maintain income flow to a preferred economic sector, than it does from the idea of freedom which drove the Revolution that created this country. As an example, Greenspan was all for instituting a Gold standard as a means to expose welfare spending as confiscation- but seemed to have no problems inflating the money supply, while suppressing the price of Gold to create welfare for financial corporations.

Both policies have the same effect, they insulate a sector of the economy from failure and thereby engender moral hazard. If welfare to the poor is believed to remove incentives to work, why don't we believe that welfare to the financial sector has the same effect- and the current crisis seems to demonstrate that the financial markets "don't work." Either we believe in the virtuous effects of competition, and driving force created by the fear of failure or we don't- or so it seems to me.

What has been apparently lost is the desire for freedom- freedom, that is, to both succeed or fail on one's own merits- to find the notion of prerogative power abhorrent however directed. As Bernard Bailyn argues in The Ideological Origins of the American Revolution, our revolutionary leaders were "eighteenth-century radicals concerned, like the
eighteenth-century British radicals, not with the need to recast the social order, nor with the problems of the economic inequality and the injustices of stratified societies but with the need to purify a corrupt constitution and fight off the apparent growth of prerogative power."

Sadly, it seems to me, debate on US economic policy for much of the past century has been on which sector to favor with prerogative power, not whether such is useful or not. As the power of the state has grown, faith in its omnipotence has followed. Thus the still apparent faith in the ability of the state to "fix" our economic ills- a faith, recalling the "Greenspan put," et. al. which allowed the causes of the ills to persist for decades.

Methinks we are soon to see an anti-King Canute event. The state will tell the tide- the tide, that is, of which Warren Buffett speaks when he talks about discovering who's been swimming naked- to stay as it is, but it will recede anyway. The abyss will become very visible.

A few weeks ago, in Power Outage on Enlightenment, I bemoaned the turning away from Enlightenment ideals- the ideals which informed our Revolutionary leaders. These leaders, in stark contrast with the men currently proposing a "unitary executive," believed in themselves, in man, not the state. They wrote of "self-evident truths," not imposed views. They were very un-revolutionary, revolutionary leaders.

As Gordon Wood argues in The Radicalism of the American Revolution: The American revolutionary leaders do not fit our conventional image of revolutionaries- angry, passionate, reckless, maybe even bloodthirsty for the sake of a cause. We can think of Robespierre, Lenin and Mao Zedong as revolutionaries, but not George Washington, Thomas Jefferson, and John Adams. They seem too stuffy, too solemn, too cautious, too much the gentlemen.....They made speeches, not bombs; they wrote learned pamphlets, not manifestos.

In sum, they believed in persuasion, not coercion. They were cautious because they were aware not only that they might fail, but also that if they did so, they would not be "bailed out." They were pragmatic before the term was coined as a philosophy- they believed the truth had a "cash value," as William James put it. The use of prerogative power, then, would only obscure the search for truth.

As Thomas Jefferson put it, It is error alone which needs the support of government. Truth can stand by itself.

Sadly, our financial system cannot.