…[T]he prevailing ethos in America has been that rich people deserve their wealth because they have created societal value for all of us. Indeed, I suspect the vast majority of the American people do not begrudge the wealth earned by successful, risk-taking innovators like Michael Dell, Jeff Bezos, the late Steve Jobs, or Ross Perot.
This leads to the conclusion that Rand’s philosophy is only anti-regulation because it is ultra-supportive of the capitalist ideal: The people who create the most societal wealth should receive the benefits of this contribution.
From this perspective, Rand’s philosophy points out that real capitalism is no longer enforced in America; not because of welfare programs, taxes, the social safety net, or government regulations, but for a very different reason: The highest paid people in America today create no real wealth for the society.
…Ayn Rand would, I believe, argue that this absolute failure to enforce capitalist principles is exactly what she most feared: The emergence of a powerful group that produces nothing, yet manages to takes a large share of the societal wealth created by others. In her view, this inevitably leads a society to implode and self-destruct.
And a final thought:
In Rand’s Atlas Shrugged, the industrialists who create the real wealth of the society start to disappear as they go into hiding. The trains that make the society work, both literally and metaphorically, stop.
So I have developed what we can call the Ayn Rand test of value: If securities traders and quants at investment firms and hedge funds started to disappear in large numbers tomorrow, would the trains that comprise our economy and society run better or worse?
You should read the entire post, because there’s a lot that’s missing from these snippets. But I want to focus on Judson’s thought experiment (bolded above) which I believe is flawed for the same reason Ayn Rand’s entire body of philosophy is flawed (which includes the naive caricatures of humanity she creates in her novels). It is based on an extreme over-simplification of reality.
Judson is encouraging us to consider what the actual value of investment banking is. And to be frank, I disagree with the implication that all investments and securities markets are suspect. I suspect that the world would in fact come to a crashing halt if our largest investment banking institutions suddenly decided to “opt-out.” Indeed, I fail to see how these institutions could ever be “too big to fail” if that weren’t the case.
At the end of the day, we need to get back to fundamentals: if we speak of Randian regulations, we can safely assume that the simpler they are, the better. In that sense, Glass-Steagall remains the preferred option. It was the repeal of Glass-Steagall that allowed financial firms to become so big in the first place, by combining deposit holdings with securities issuance, and all that entails.
In short: Investment banking isn’t existentially suspect. It has a role in Capitalist societies. Allowing investment banks to under-write their investments by using the rights and privileges designed for deposit-holding institutions, however, is suspect. The answer is not for Wall Street to go Galt. It’s for Washington to go Steagall. Glass-Steagall.
Clarification for those that may find this headline confusing: the judge wasn’t striking down the ruling to benefit Citigroup. He did it because he feels that Citigroup shouldn’t be allowed to bargain its way out of being held accountable for wrong-doing.
The problem, of course, is that the SEC has discretion on whether to bring charges or not. And the SEC might decide that taking the case to trial is not worth the taxpayer’s expense (and you can bet it will be an expensive one, given the defendant and amount in controversy).
I had the pleasure of being in the audience for a panel of Albany Law School alumni that work as lawyers in the financial industry. The panelists included legal counsel for Jamie Dimon (hereafter LJD), in-house counsel for Bank of America, a Vice President and in-house counsel for a medium-size financial firm, and legal counsel for an international mutual fund, with offices in America and Germany.
Inevitably (as you might imagine), the question of too-big-to-fail institutions came up, as well as the efficacy of Dodd-Frank. The recent collapse of MF-Global also came up as well. Everybody has nuanced opinions on Dodd-Frank (the consensus view being that there were some good provisions in it, but that many of them were untested ideas that were already having unintended negative consequences that will find their way back to the pockets of Main Street in one way or another).
Two things caught my attention during the discussion:
1. The collapse of MF Global. The LJD panelist mentioned that MF-Global was not a bank, and so they could not rely on the Fed as a lender of last resort to maintain liquidity. He also mentioned that there was absolutely no reason to bail out MF-Global because they should reap the fruits of their bad bets, i.e. Capitalism always has winners and losers, and the losers should be allowed to fail. Otherwise, the taxpayers are on the hook for those bad bets. HOWEVER, the LJD panelist also mentioned that he felt the Fed plays an absolutely vital role in our financial system, because it is the only financial institution with the policy tools capable of responding to the types of systemic risk that materialized, say, during the 2008 Crisis; or that may arise due simply to the fact that financial markets are global, and a lack of unity in twin areas of monetary and fiscal policy necessarily leads to imbalances that need to be addressed. He pointed specifically to the Euro-zone crisis as evidence that 1) non-unity between monetary and fiscal policy can have disastrous effects, and 2) the absence of a lender of last resort has left several European governments in crisis, which negatively impacts all countries who use the Euro.
2. Bank of America’s derivatives shuffling. A member from the audience asked counsel for Bank of America (BoA) about the recent decision to move $53 trillion in derivatives to one of its holdings divisions which is insured by the FDIC. This arises from the fact that this division has $1 trillion in deposits that serve as a back-stop for the $53 trillion. What that means is that, because the division is a deposit-holding institution, all of its assets are insured by the FDIC. This has created an interesting dissonance between the Fed, who supports the measure on the basis of soundness, and the FDIC, who doesn’t have anything approaching the assets necessary to insure $53 trillion in derivatives. The BoA panelist said that he couldn’t get into too many details about the transaction (since he is a lawyer and has a duty of confidentiality), however, he said that BoA was aware that the transaction was controversial, and said that they specifically designed the transaction so all of the assets were “riskless,” i.e. it was largely a cosmetic transaction obviated by the fact that Moody’s recently down-graded BoA’s Merill Lynch unit to Baa1, three steps above junk status.
In response to these two issues, two things came to mind:
1. ‘Riskless’ transactions. The idea of something being a “riskless” transaction is problematic to me. The derivative-trading strategies that led to the financial crisis were developed on the basis of Algorithms known as Gaussian Copulas, which were supposed to eliminate the risk of financial loss to an infinitesimally small margin, such that profitability was virtually ensured. The problem is that the designers of the Gaussian Copula never accounted for what would happen if those investments did fail. It turns out that all the Copula was doing was accumulating those infinitesimally small risks into ever-growing complex securities that investors packaged based on a false assumption: that each infinitesimally small risk was independent of the other, and would never come to pass. We all know how well that worked out.
2. 3-part problem. Based on everything I’ve mentioned so far, I see three problems that are being identified by the panelists:
a) Too-big-to-Fail institutions
b) The ability of Banking institutions to use the FDIC to insure investment instruments rather than deposits.
c) The ability of banks who have combined investment and deposit-holding functions to use the Fed as a lender of last resort (which only deposit-holding institutions can do, hence why MF Global couldn’t rely on the Fed as a lender of last resort to prevent its collapse).
The repeal of provisions of the Glass–Steagall Act by the Gramm–Leach–Bliley Act in 1999 effectively removed the separation that previously existed between investment banking which issued securities and commercial banks which accepted deposits. The deregulation also removed conflict of interest prohibitions between investment bankers serving as officers of commercial banks. This repeal may have contributed to the severity of the financial crisis of 2007–2011 by allowing banks to become so large, complex, and intertwined that both they and their regulators failed to see the systemic risk that a failure in one part of one bank could lead to cascading failures across the global financial system.
If we re-instate Glass-Steagall, all of the big banks, as we know them, would cease to exist in their current form. Understand what this would do:
1. Investment banks would no longer be able to use the Fed as a lender of last resort by virtue of being simultaneous deposit-holders. That means the Fed is no longer underwriting the bad bets of large institutional investment firms. It means that if JP Morgan makes bad investments, it goes the way of MF Global.
2. Bank of America would no longer be able to move $53 trillion in derivatives into an FDIC-insured holding subsidiary, because it could no longer simultaneously be a deposit-holding institution and an investment bank.
3. The immediate separation of deposit-holding and investment functions, and the foward-moving prohibition on any firm conducting both functions at the same time, would shrink the size and exposure of every single large institutional financial firm virtually overnight. Becoming too-Big-to-Fail becomes difficult if not impossible under Glass-Steagall.
Glass-Steagall was repealed in 1999, and bi-partisan proposals to re-instate it were introduced in 2009. Unfortunately, a half-measure, known as the Volcker Rule, was introduced into Dodd-Frank. It’s better than nothing, but it fails to address the systemic problem: financial institutions have an incentive to combine deposit-holding and investment functions under one flag, for reasons stated above. Those incentives, however, revolve around the bank’s personal interest, and not the systemic exposure that inevitably accompanies merging the investment and deposit-holding functions of two firms into a single entity.
Instead of passing 1,000 pages of new regulation, we should just pass a fairly simple regulation that was repealed in 1999 so that large firms could increase their capital flows and exposure (and thereby make more money in the process).
We should repeal Dodd-Frank and re-institute Glass-Steagall. Many of the systemic problems that caused the 2008 financial crisis would be eliminated by separating the deposit-holding and investment banking functions on Wall Street. We don’t need a megalith like Dodd-Frank when we can solve the same problem with a smaller, simpler, concise, easy-to-apply regulatory framework like Glass-Steagall.
Very sad indeed. As I contemplated the motivation of the rhino poachers, I wondered to myself: isn’t it economically irrational to poach the source of your income into extinction? Wouldn’t a rationally self-interested poacher modify their behavior to make their practices more sustainable?
As I considered this, I thought about something that Ludwig Von Mises said about the role of consumers in free markets:
The captain is the consumer…the consumers determine precisely what should be produced, in what quality, and in what quantities…They are merciless egoistic bosses, full of whims and fancies, changeable and unpredictable. For them nothing counts other than their own satisfaction…In their capacity as buyers and consumers they are hard-hearted and callous, without consideration for other people…Capitalists…can only preserve and increase their wealth by filling best the orders of the consumers… In the conduct of their business affairs they must be unfeeling and stony-hearted because the consumers, their bosses, are themselves unfeeling and stony-hearted.
It occurred to me that, in this context, the short-term benefit which these poachers receive must be massive enough that it shrinks their concern for sustainability. The time-value of money and Bounded Rationality conspire to ensure that sustainable practices are pushed to the outer recesses of a “reasonable” poeacher’s mind. The consumer, in other words, is the poacher’s captain. And he wants his rhino horns.
Yet, in spite of the relationship between consumer and poacher, I think that we can agree that the extinction of this species is a net negative to humanity. If we can agree on that proposition, then by what mechanism could an unregulated market prevent this situation from occurring? It seems to me that the Bounded Rationality of these poachers, alongside short-term economic incentives, virtually ensures that the poachers wouldn’t make the leap of logic necessary to take a more sustainable approach. Indeed, this very same thing just happened in Vietnam with a different species of rhino. The poachers have once more poached themselves out of a living: a seemingly irrational result that economic incentives theoretically should have prevented before it got to that point. And yet those same incentives did not move these poachers to cease their poaching activity before it reached the point of extinction; thus putting the poachers out a job.
If anything, this is a situation, much like the coal industry, where market forces do not naturally lead to the ideal result, meaning that regulations (however inefficient and imperfectly enforced), must be put in place to correct for the short-term incentives that would lead a “rational” poacher to act in this manner. To borrow some lengthy commentary from April:
Often what regulations do is correct for the lack of a price control for externalities that sellers don’t have to pay for directly. Take the coal industry for example:
Each stage in the life cycle of coal—extraction, transport, processing, and combustion—generates a waste stream and carries multiple hazards for health and the environment. These costs are external to the coal industry and are thus often considered “externalities.” We estimate that the life cycle effects of coal and the waste stream generated are costing the U.S. public a third to over one-half of a trillion dollars annually. Many of these so-called externalities are, moreover, cumulative. Accounting for the damages conservatively doubles to triples the price of electricity from coal per kWh generated, making wind, solar, and other forms of nonfossil fuel power generation, along with investments in efficiency and electricity conservation methods, economically competitive. We focus on Appalachia, though coal is mined in other regions of the United States and is burned throughout the world.
So let’s say that someone gets cancer from breathing in coal dust near a coal mine. They and their insurance company then, cumulatively, spend 100’s of thousands of dollars on treatment. And that’s one person. The coal industry doesn’t have to pay that cost. But it does drive up the cost of healthcare. Regulation can help transfer some of this cost away from the healthcare industry and back to the coal industry, where the price mechanism will properly account for the externalities that it produces.
Whereas coal involves negative externalities, the problem here is short-sightedness. Short-term economic incentives have driven these poachers to hunt rhinos for their ivory; and indeed, as rhinos become rarer, the problem of scarcity assures that the price of rhino horns will increase in proportion to their scarcity. So instead of curbing their activities to make them economically sustainable, the short-term economic incentives of the poachers will conspire so as to incentivize them to hunt rhinos until there’s none left. These two cases, in Africa and Vietnam, lend direct support that theory.
I don’t see how you can prevent this result from occurring without top-down regulation to correct for the short-term economic incentives that would prevent a “reasonable” poacher from pursuing more sustainable practices. I think this case demonstrates another example of a facet of human action in which unregulated market forces can lead to an undesirable result due to the interaction of complex human incentives, which can take multiple forms and lead to non-ideal/self-destructive circumstances, as each stakeholder pursues their self-interest independent of what the rest of us believe to be ideal results; results which can always be priced out of consideration in the short-term.
Louisiana law purports to require that anyone who is going to sell a casket has to jump through all same regulatory hoops as a full-fledged mortuary operation that embalms bodies. See, selling “funeral merchandise” (including caskets) means you are a “funeral director.” And to be a “funeral director,” you must be approved for “good moral character and temperate habits” by a funeral-related government entity [of course, that’s in Louisiana, but still], complete 30 semester hours at college, apprentice with a funeral director for a year, pay an application fee, and pass an exam. But that’s not all. If you want your facility to sell caskets, it’s got to qualify as a facility for funeral directing, including a showroom and “embalming facilities for the sanitation, disinfection, and preparation of a human body.”
So, to sum up: Louisiana would like the monks of Saint Joseph to take college classes, intern with a funeral director for a year, pass an exam, pay a fee, be approved by a board, and convert part of their monastery into a professional mortuary in order to sell hand-crafted wooden caskets. If they don’t, they are guilty of a crime.
This was classic rent-seeking: a protectionist measure calculated to defend Louisiana’s existing “funeral directors” from competition, so that they could continue to sell over-chromed ass-ugly caskets at an enormous markup.
At the time, I expressed skepticism that the ILJ would succeed in its suit.
The Honorable Stanwood Duval of U.S. District Court for the Eastern District of Louisiana ruled, “Simply put, there is nothing in the licensing procedures that bestows any benefit to the public in the context of the retail sale of caskets. The license has no bearing on the manufacturing and sale of coffins. It appears that the sole reason for these laws is the economic protection of the funeral industry which reason the Court has previously found not to be a valid government interest standing alone to provide a constitutionally valid reason for these provisions.”
As many of you know, I’m not an anarchist. I think government has some role, albeit a small one, in regulating an economy to ensure maximum competition. Note I don’t say promote: to suggest government should promote competition is to say the government should actively intervene in an economy in order to boost the competitiveness of some firms. In plain language, this strongly implies subsidies.
Rather, a free market is the best kind of economy because it is the most effective epistemological device that collects aggregate economic information, filters it, and then disseminates the relevant bits and pieces of that information to each participatory individual. In other words, the free market is like a giant search engine.
However, notice that this means that my conception of a free market rests on a very fundamental assumption: namely that information must be largely accurate and that there must be a sufficient quantity of information for the market to analyze. And sometimes, the natual situation of a market can lead to a situation in which there is an imbalance of information. Some involved parties are not aware, and certain parties do not offer full transparency. This is where, I believe, it is one of the few times for a government to step in to correct the situation, and regulations are a necessary aspect of correcting and preventing this.
My more liberal readers will probably nod their head in agreement, but to the libertarian, you are probably convulsing, foaming at the mouth and saying “WHHHHHHY! WHY REGULATIONS JUSTIN!!!! THAT’S THE GOVERNMENT!” and hiss like rattlesnakes ;)
I kid for humors sake, but on a serious note, some of you may be asking why the market can’t address this issue. Before we get into that though, I want to remind libertarians of one crucial portion of the Non-Aggression Principle that often gets forgotten about: it is immoral to initiate either force or fraud. However, as a minarchist, I realize sometimes it is necessary to use a small bit of force to offset a great ammount of fraud. And if you think fraud is somehow not harmful, then clearly you don’t understand why it is a part of the NAP. Fraud, especially financial fraud, has the power to destroy entire economies. Just look at what happened in 2008, due to the accounting fraud of Bear Stearns, AIG, Merrill Lynch and company. Even to this day, we have entities like Bank of America whose fraud in mortgages is starting to unravel and expose itself. It’s readily obvious why such fraud should be legally prevented.
In a market, I believe that it’s not necessarily in the best interest of a fraudulent company to reveal that they are fraudulent. I mean, this is just sort of common sense: if we already acknowledge that these companies are fraudulent, then by the very definition of what it means to be fraudulent, we implicitly admit that it is in the rational self-interest of these companies to be deceitful regarding their fraud.
And yes, I understand caveat emptor and all that. But remember, part of our NAP is preventing fraud. And although regulations are certainly not perfect, I think they are an ideal solution to a few financial and economic problems when used judiciously and appropriately. Common-sense notions, such as banks should be forced to disclose the ammount of debt they are in, statistics related to their solvency, etc are quite appropriate to regulate in the sense that these facts need to be made explicitly public and freely available. If we want consumers to make rational decisions, which is one of the things a free market relies upon, consumers must have as much relevant and necessary information as possible in order to make the most rational decision. It is thus in the best interest of every individual to legally force companies to disclose this sort of information and make it publicly known.
Senator Bill Nelson of Florida has been pushing the Interior Department to enact regulatory curbs on the importation of Burmese pythons into the United States. Apparently they’ve been infesting the Everglades and doing a great deal of damage. And according to the House GOP, this sort of thing is exactly why unemployment rate is over 9 percent:
But in a report released Wednesday, Republicans on the House Oversight and Government Reform Committee denounced the proposed rule as part of the Obama administration’s “regulatory tsunami.” They said the snake ban could “devastate a small but thriving sector of the economy.”
I, personally, am an invasive species sympathizer (who are we, humans, if not the ultimate invasive species?) so I see where the critics are coming from, but this highlights precisely how petty and absurd efforts to tackle mass unemployment purely on the supply side are going to be. We don’t need four jobs selling snakes somewhere. We need millions and millions of jobs. We need well over a million new jobs per year just to keep up with the growing population rate. To get the employment-population ratio back up to its late ’90s peak would require hundreds of thousands of jobs per month for years. Snake imports aren’t going to cut it. Trade deals with tiny countries like Panama aren’t going to cut it. Picking nits about where Boeing does and doesn’t open factories isn’t going to cut it. The United States of America is a gigantic country with a gigantic economy and a gigantic labor force and a gigantic problem of joblessness. You need to move it with big levers. Snake-led growth doesn’t cut it.
Jay Livingston slams a GOP talking point lent legitimacy by Gary Becker:
[Becker] pushes uncertainty to the front of the line-up and says not a word about the usual economic suspects – sales, costs, customers, demand. It’s all about the psychology of those in small business, their perceptions and feelings of uncertainty, Not only are these vague and hard to measure, but as far as I know, we do not have any real data about them. Becker provides no references. The closest thing I could find was a small business survey from last year [above], and it showed that people in small business were far more worried about too little demand than about too much regulation.
A leaked EPA memo is being cited by scientists as smoking gun evidence of likely cause of the massive die-off of honeybees. The culprits, these researchers claim, are Bayer CropScience and the Environmental Protection Agency (EPA).
The memo details how Bayer performed facially inadequate testing on the pesticide clothianidin and then EPA accepted the results to release the pesticide without adequate proof that it would not harm the bee population. The EPA gave conditional approval in 2003 and let Bayer sell the product.
The EPA memo dated November 2, 2010 says that the EPA accepted the flawed research and only told the company to complete further safety testing by a certain deadline. The company did not complete the research for years and instead fought to get extensions on its conditional permit. The final testing was reportedly flawed — performed in another country with bees that were located on a small patch of treated crops surrounded by thousands of acres on untreated crops. The EPA quickly embraced the defective study and gave full registration to clothianidin in 2007 during the Bush Administration. Yet, even in the Obama Administration in November, 2010, the EPA did not act when the company filed for another extension.
On a political level, this is a fascinating story since many Republican candidates have been calling for the elimination or reduction of the EPA to help the economy. The loss of the honeybees represents a catastrophic blow for agriculture in the United States. Even if you are a candidate with little concern for public health or the environment, this is an example of how pollution or harmful chemicals hurt the economy.
On a legal level, the story would create an interesting question if true. The company stands accused of doing rigged and delayed field testing in order to get a defective product to market. The result is claimed to be the devastation of honeybees that are vital to farms and other businesses. Can they now sue? The problem will be proving causation in such a massive tort case. Of course, a trial would produce greater scrutiny than was the case at the EPA.
I am also concerned that this memo had to be leaked. Once again, neither the agency nor Congress informed the nation of this evidence for years as the world has searched for a cause of the loss. Even if this is not found to the cause or only cause, there remains questions of why this company was able to introduce such a chemical into the environment with so little scrutiny. The reliance on industry testing has long been controversial and the lack of serious scrutiny during both the Bush and Obama Administrations shows how industry continues to exercise a disturbing degree of control over the data used to evaluate their products.
the difficulty of proving such an attenuated Proximate Cause in a Tort case is precisely why Property Rights alone are insufficient to protect the environment; hence requiring regulatory oversight. The farmers are also going to have an extremely difficult time demonstrating that any losses they’ve experienced were caused-in-fact by the honeybee extermination. The connection is so difficult to show in court that demonstrating an injury is virtually impossible.
And the farmers have the best case among anybody. Who else has standing to sue when animals and insects are killed? The families of the honeybees?