Deep insight from Eugene White in this paper (HT: Scott Sumner)
The fantastically costly failures of banks and other financial intermediaries are a consequence of appallingly bad choices made by managers. To gain unseemly executive compensation, managers had incentives to exploit conflicts of interests, increase leverage, and choose risky trades, instruments and portfolios. Reacting to these disastrous choices, policy makers have recommended splitting up the banks to make them smaller or limiting the scope of their activities. Elaborate efforts are being expended to ensure that leverage is controlled by raising capital and by gauging its exposure to the individual banks’ risks and systemic risk. Lastly, there have been calls for caps on executive compensation to reduce the rewards from risk-taking. These are very strong measures, but history suggests that they will not be lasting checks on risk. Previous reforms focused on regulating choices ultimately led to new institutions and instruments that circumvented the rules to take more risk.
Part of the recent crisis’ origins may be found in steady erosion of incentives that induced management to control risk. The problems of moral hazard from deposit insurance, “Too-Bigto-Fail,” and the “Greenspan Put” are well-known, though their magnitude is difficult to measure. In addition, the increasing ability of management to control the boards of directors has insulated them from efforts of rebellious shareholders to appoint new directors. Perhaps, the White most important but least heralded change in the ten years prior to the 2008 crisis was the shift by most major investment banks from partnerships to limited liability corporations.
What is notable about contemporary reform is that there is little effort to change the incentives that caused bank executives to take the big risks and a huge emphasis on regulating their choices. The implicit assumption seems to be that incentives and the assignment of liability plays only a small role so that choices must be regulated—that is, the market cannot be made to adequately discipline banks. Could such a market-based system be devised? In this paper, I offer evidence from the American National Banking Era (1864-1913) for the ability of incentives to successfully limit losses from bank failures
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… is from pages 8-9 of Mark Pennington’s 2011 book Robust Political Economy:
Moreover, insofar as market failure theorists are right to focus on ‘incentive compatibility’, they fail to appy this analysis to their favoured institutional alternatives. A consistent analysis of collective action and asymmetric information problems reveals that these are often more pronounced in a public sector environment than they are in a regime of ‘imperfect markets’.
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Here’s a letter to the Wall Street Journal:
Lobbyist Scott Paul details the bounty that American tire producers now reap from the Obama administration’s tariff on Americans who buy Chinese tires (Letters, Jan. 26). He then asserts that these gains prove the tariff’s merit.
Bull.
The argument against tariffs is not that they fail to yield benefits to protected industries; rather, it’s that these benefits come at the greater expense of the public at large. Mr. Paul’s letter is evidence of the truth of Albert Venn Dicey’s observation that “Every man feels or thinks that protection would benefit his own business, and it is difficult to realize that what may be a benefit for any man taken alone, may be of no benefit to a body of men looked at collectively.”*
Mr. Paul’s false assumption that the gains to tire manufacturers are gains to Americans at large proves not the merit of the tire tariff but, instead, the narrowness of the tunnel vision of a rent-seeking lobbyist and of the rapacious corporations that he serves.
Sincerely,
Donald J. Boudreaux
Professor of Economics
George Mason University
Fairfax, VA 22030
* Albert Venn Dicey, Lectures on the Relation Between Law & Public Opinion in England During the Nineteenth Century (London: Macmillan and Co., 1905), p. 24.
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… is from page 63 of John Mueller’s outstanding 1999 book Capitalism, Democracy, and Ralph’s Pretty Good Grocery:
From the perspective of the intellectual, then, people in business may appear small-minded, crass, menial, and even stupid – though typically they will understand their business in greater depth and finer nuance than the average intellectual will ever understand anything.
Yep – although it’s wise to add that to understand one’s business is not (contrary to much popular misconception) simultaneously to understand adequately the workings or the logic of the larger economy of which that business is a part. The average intellectual, alas, understands neither the complex of details and trade-offs regularly involved in running businesses (or even in the making of everyday household decisions by families other than his or her own) nor the workings or the logic of the larger economy.
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Here’s a letter to the Wall Street Journal:
Having now read Pres. Obama’s 2012 State of the Union address (I cannot tolerate watching the kitschy display that is the actual delivery of a State of the Union address), I can say only that Thomas Babington Macaulay’s long-ago description of Robert Southey applies perfectly to Barack Obama:
“He conceives that the business of the magistrate is not merely to see that the persons and property of the people are secure from attack, but that he ought to be a jack-of-all-trades, architect, engineer, schoolmaster, merchant, theologian, a Lady Bountiful in every parish, a Paul Pry in every house, spying, eavesdropping, relieving, admonishing, spending our money for us. His principle is, if we understand it rightly, that no man can do anything so well for himself as his rulers, be they who they may, can do it for him, and that a government approaches nearer and nearer to perfection in proportion as it interferes more and more with the habits and notions of individuals.”*
Sincerely,
Donald J. Boudreaux
Professor of Economics
George Mason University
Fairfax, VA 22030
* T.B. Macaulay, “Southey’s Colloquies on Society” (1830).
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by Don Boudreaux on January 25, 2012
in Budget Issues, Debt and Deficits, Hubris and humility, Inequality, Myths and Fallacies, Politics, Seen and Unseen, Taxes, Video, What's wrong with the country, Work
There was actually a news-worthy moment in Mitch Daniels response to President Obama’s State of the Union address. He said:
Decades ago, for instance, we could afford to send millionaires pension checks and pay medical bills for even the wealthiest among us. Now, we can’t, so the dollars we have should be devoted to those who need them most.
The mortal enemies of Social Security and Medicare are those who, in contempt of the plain arithmetic, continue to mislead Americans that we should change nothing. Listening to them much longer will mean that these proud programs implode, and take the American economy with them. It will mean that coming generations are denied the jobs they need in their youth and the protection they deserve in their later years.
I would prefer to slowly dismember Social Security and Medicare and instead let us re-learn how to take care of ourselves and our neighbors without going through Washington. But if the goal is to save the system in some form akin to its current state, making the welfare component of Social Security and Medicare is a good place to start. Why should your children be taxed to pay for my retirement when I am capable of taking care of myself? The usual answer is that I paid into the system and I deserve “my” benefits. But I also paid into Food Stamps. I don’t expect my food stamp tax payments to come back. The government has deceived the American people for years, making them think that their payroll tax “contributions” are set aside for their future benefit. But it’s not true. So let’s just admit it’s a welfare program. And if it’s a welfare program, why do rich people get benefits? Means-testing Social Security and Medicare would allow much lower tax rates in the future and be a more honest way to structure government-financed retirement and health plans.
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… is from page 201 of my colleague Richard Wagner’s valuable 1987 essay “Liability Rules, Fiscal Institutions and Debt,” which is chapter 11 in the important 1987 collection Deficits (James M. Buchanan, Charles K. Rowley, & Robert D. Tollison, eds):
The claims of Keynesian macroeconomic theory and policy may or may not be correct; I for one think they are quite false. But political survivability may be quite different from such matters of truth or falsity. Even if the Keynesian presuppositions about economics were true, and so the economy were unstable and government could alter its budgetary policy to offset private sources of instability, it does not follow that those policy outcomes would dominate alternative policies within existing democratic regimes. Moreover, even if those presuppositions were false, policy prescriptions based on those presuppositions could nonetheless have survival value within existing democratic institutions.
From this reality I conclude that it’s professional malpractice for a social scientist who pays little attention to the realities of how how collective-choice and government-decision-making processes actually work – namely, by carefully studying public choice – to advocate that government implement his or her theories. Policy advocacy under such circumstances is professional malpractice regardless of the strength of the conviction with which the social scientist holds his or her theories to be true (and, indeed, regardless of the actual validity of those theories within their own theoretical domains).
Policy advocacy by persons insufficiently familiar with public-choice research is akin to, say, an automotive engineer designing an automobile with all sorts of (what are at least believed to be) internally consistent working parts, all of which conform well to known laws of physics, but none of which was designed with much knowledge at all of the actual features of the likely human beings who will drive the car – features such as people’s size, vision, the number of limbs they possess, and the purposes for which they likely are to use the car.
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by Russ Roberts on January 24, 2012
in Politics
The title of this post is my new summary of the top two Republican candidates. You can pronounce it in two ways and both capture my lack of enthusiasm for them.
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