Now that financial apocalypse has been (possibly) delayed a few weeks, let's focus on the mortgage crisis and see what it teaches us about financial regulations in general. Mortgages once were great investments. When lenders were highly regulated and careful never to lend more than the underlying value of homes, mortgages provided a higher return than U.S. Treasury bonds with almost as little risk. People went to great lengths to keep their homes, and when they got in over their heads, lenders could still recover most of the principle.
The problem, of course, was that there was a limited supply of really safe mortgages. So originators started making slightly risky loans, followed by riskier ones, and then riskier still. Part of deregulation resulted in lowering reserve requirements, meaning that investors could lend out more and more money they did not have. Another part was that mortgages could be originated by institutions not subject to such regulation in the first place. It was not just a matter of bad loans, but of loans made with non-existent money. (Though it is not quite the same, a fair comparison would be check-kiting.) So as demand for mortgages rose, originators could provide a shakier and less sound supply. Since lenders could turn around and resell all or most of their notes, originators often ended up without liability for bad loans they made.
Why did buyers continue to invest in a high stakes version of "Find the Lady"? Think of the late Lehman Brothers or any investment fund with row after row of brokers, competing to look good to the boss. Once one desk bought into the game, other brokers stayed out of it at the risk of their job. Only a tiny percentage of investment funds, such as those controlled by Warren Buffet, were outside this environment of adverse selection.
And this is not an exception in finance. Investment funds are always under pressure to take bigger and more foolish risks. Any financial sector that grows big enough in the absence of regulation will turn into a bubble. The great depression, the savings-and-loan scandal in the '80s, the internet bubble in the '90s -- all grew out of under-regulated environments. Heck, so did the South Sea bubble in the early 18th century.
Environmentalists can learn two important lessons from this:
One: if regulation is essential to finance, then so-called "command-and-control" remains one important tool in making the economy both greener and more prosperous.
Two requires more explanation. Start with the premise that many of these regulatory failures are regulatory capture. Some of earliest, such as the South Sea Bubble, occurred before anyone really considered the need for such regulations. But, at least in the 20th and 21st centuries, lobbying and ideological victories by the very rich and powerful either prevent regulations from being instituted in the first place, or more recently, push the repeal of regulations that already exist and the non-enforcement of those that remain.
The existence of regulatory capture is one of the classic arguments against regulation. If the foxes will end up in charge of the henhouse, just let chickens loose in the woods to begin with. But if you agree that capitalism needs strong regulations uncontaminated by regulatory capture, that leaves quite a dilemma.
The dilemma can be avoided, or at least replaced by a new dilemma, if you notice that most serious regulatory capture is instituted by those who are rich and powerful as compared to the population. There are exceptions, such as some of the extreme licensing regulations, where comparatively powerless trades protect themselves at the expense of people much worse off than themselves. But such cases are rare compared to regulatory capture by super-elite "Masters of the Universe."
The solution is clear: Reforms, especially new regulations, have to be accompanied by increased social and economic equality. Capitalism needs regulation, but regulation tends to be undermined by extreme inequality. So people supporting market solutions need to support regulation to make those markets work -- and more equality to make those regulations work. Ultimately, environmentalism can't be beyond left and right. Even support for market solutions can't be beyond left and right. If you support capitalism and markets and are serious about making them work, you have to support social and economic equality. Equality is not something nice, something extra to worry about later. It is fundamental to saving our asses from an environmental crisis like climate chaos, and fundamental to saving our asses from an economic crisis like the current depression.
My next post will deal with the relation between the financial system and "the real economy," and why the line between them is not as sharp as it seems -- why finance is part of the real economy, and why people who criticize the focus on finance have a lot of truth on their side, even though it needs to be stated better.
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Comments
View as Flat
Delay And Deny Posted 4:17 am
14 Oct 2008
'Zero net energy' homes: an experiment in Issaquah
A Seattle-area developer and local governments have teamed up to build townhouses that, in theory, will give back more energy than they use. Will that work? It will depend in part on who lives in them.
By Francesca Lyman
What's less than zero? We're not talking about the corporate income tax or the price of a foreclosed property in Seattle. In fact, sometimes less than zero can actually add up to more than zero. We're talking about something new under the sun: "zero net energy" homes, often equipped with solar power, which are designed to generate more energy than they consume.
"Picture living in a thermos bottle," says Seattle builder Doug Howland of Howland Homes. He was explaining the concept at the groundbreaking of zHome, a "zero net energy" housing development he's building outside Seattle. The idea is to insulate the house so tightly that heating and cooling requirements are drastically reduced. "Yet it stays warm or cool."
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stevenearlsalmony Posted 4:34 am
14 Oct 2008
Is the world's financial system organized and operated as a colossal, soon to become, patently unsustainable pyramid scheme?
Given its artificially design and structure, is there even so much as a chance that the manmade economy is approaching a point in history when the global economy's colossal scale and relentless rate of growth could produce some sort of unimaginable ecological calamity unless, of course, the unbridled global growth of the leviathan-like economy hits the 'wall' named "unsustainability" where it crashes before Earth's ecology is collapsed?
Steven Earl Salmony
AWAREness Campaign on the Human Population, established 2001
http://sustainabilityscience.org/content.html?contentid=1 ...
http://sustainabilitysoutheast.org/index.php
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GreenEngineer Posted 5:03 am
14 Oct 2008
The solution is clear: Reforms, especially new regulations, have to be accompanied by increased social and economic equality. Capitalism needs regulation, but regulation tends to be undermined by extreme inequality.
I think that what you meant to say is that inequality tends to subvert regulation (i.e. leading to capture) rather than undermine it (i.e. cause it to be canceled, or not enforced).
Be that as it may, I think your statement takes an enormous problem and tries to sweep it under the rug. I'll accept that greater equality will lead to more fairness overall. That's practically a tautology. But unless you envision a society based on near-perfect equality, most especially one with no elite power class, I don't think that your proposed solution really addresses the problem. And I think that a solution that requires us to get rid of the elites fails the plausibility test. It's been tried before, and all its ever done is replaced one elite class with a new one. Like the poor, the powerhungry will always be with us. We need a more robust solution to control them than "increased equality".
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Russ Posted 5:10 am
14 Oct 2008
Even leaving bad intent out of it, just the inertia of large wealth and power concentrations tends toward greed, capture, and corruption. The omnipresent temptation to take a path which is both easier and more lucrative is a clear and present danger to the integrity of anyone who's not a saint.
You could say large concentrations, of their own accord, seek to become larger. The will to power is always operative even where people aren't consciously going Mwaa-hah-hah and rubbing their hands in crapulent anticipation.
We should look at this in terms of inherent imbalance, instability. A chasm of inequality and a mountain of concentration destabilize the economy, politics, and society.
As for the financial system vis the economy at large (to anticipate the next post), what's to me the obvious confluence is that finance is just the distillation of the general debt psychosis. The physical economy too is based on exponential debt and exponential growth, and is in fact just as untenable a structure, teetering just as precariously, as the finance Tower.
Nobody in any business has any experience of staying within his means. Everyone knows only how to pay with funny money, "credit", and pretend everything will be straightened out in some vague future which is never really supposed to come. It's musical chairs where there are infinitely more players than chairs, but everyone assumes the music will never in fact stop.
In recent months I've often come across the iceberg metaphor - that the travails of finance are just the currently most visible portion of a looming cataclysmic margin call which will resound across the entire economy, but which cannot be answered. That Wall St's ailment will spread to Main St, that credit freezing up will force the contraction of real-economy business activity, is a possibility, but I think it's secondary to the underlying untenability of the general macroeconomic debt exponent, whose curve can only get so steep before gravity forces it to fall back upon itself, like a breaking tsunami.
This will be the mother of all debt implosions.
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Jon Rynn Posted 5:13 am
14 Oct 2008
For instance, manufacturing jobs tend to increase equality, because they are well-paying, and when the US had a larger manufacturing sector, the US was more equal. A healthy labor movement is also very helpful, as we see in Europe, and in Scandanavia, where the labor movement has a permanent seat at the table.
A more radical possibility is to have all firms be employee-owned-and-operated, which would radically decentralize economic power. It would be somewhat the equivalent of the 19th century situation in the US when (free) farmers were, to some extent, the basis of equality in the US.
Then, of course, there is also the tax system -- Kevin Phillips has been writing for years about the interaction of a superwealthy class and democracy. The Roman upper class tried to push off all tax burdens on the "plebes", with devastating results, and upper classes have been trying to do that every since.
Finally a policy of "full employment", as it used to be called, would give the working and middle class more power. That can be achieved with fiscal/indirect policies, or by direct policies of the government simply hiring people to do work -- like, for instance, transforming the US economy to be carbon-free.
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GreenEngineer Posted 7:30 am
14 Oct 2008
But I don't see how these measures would address the problem of regulatory capture. Whether a company is owned by investors, the founders, the VCs, or the employees, it's still going to have an incentive to try to buy legislation that is favorable to it and/or unfavorable to competitors. That's the question I would like to answer.
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Jon Rynn Posted 7:56 am
14 Oct 2008
So, in the regulatory domain, in the executive branch, these same interest groups can also capture parts of the government (the economist Mancur Olson referred to an excess of this as "sclerosis" of the body politic).
I think "capture" is an inevitable part of a democratic political system, and to some extent it should simply be tolerated as such. The big problem, I think, is when the regulation becomes completely hobbled by its parasites, as it were.
This is were an educated, concerned, participatory citizenry comes in, I think, as a counter to capture. To some extent, groups such as environmental groups can also offer some organized challenge, and also the consumer watchdog stuff that Nader started.
So the question is: would greater equality lead to better public oversight? I think you can argue that it would -- the progressives, for instance, were very much the product of the middle class. In fact, you could argue that much of the grassroots work from the 1960s came because of the huge, prosperous, confident middle class, and people such as Thom Hartmann have argued that part of the agenda of destroying the middle class is to prevent this organizing from taking place.
So I guess the logic would be, greater equality leads to a stronger middle class leads to greater organizing and activism leads to greater public oversight over regulatory agencies and legislatures, leads to a better environment (and other things).
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Gar Lipow Posted 2:02 pm
14 Oct 2008
Burke was an advocate of this in politics in general in the 18th century. During his lifetime it was common to condemn "faction" - political parties, much as it is common to condemn "partisanship" in ours. And Burke argued that, yes it would be great if you just had pure disinterested politics, thinking only of the greater good,free of passion or self-interest. But given the unlikeliness of this, the next best thing was to have a lot of factions canceling one another out, so that the only way to build coalitions was appeal to the greater good, or at least to interests of factions adding up to an majority - which was imperfect, but still useful approximation of that greater good.
In today's environment when the public face of conservatism is the rabid attack dog, proud its own viciousness and ignorance, it is worth remembering that there is a conservative tradition of caution, deliberation and balance, of settling for an achievable second best rather than an impossible perfection. Conservatism does not have to be just a mask worn by murders and thieves. As conservatives have rejected so much of what was once good in conservative traditions, liberal and lefties can perhaps learn and adapt some of them: skepticism about over-reliance on virtue that does not take in account human weakness and irrationality, a suspicion of abstract principle that is immune to empirical correction. There was even a time when conservatives were not eager for the disruption of war.
Modern conservatives need to rediscover Jonathan Swift,Burke, Disraeli, G.K. Chesterton and C.S. Lewis (hopefully rejecting the antisemitism Chesterton repented of near the end of his life). The modern conservative movement has made the term "compassionate conservative" a bitter joke, a contradiction in terms. But there really was once a tradition of humane conservatism, of "Red Tories".
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GreenEngineer Posted 5:39 pm
14 Oct 2008
OK, I see your point. It seems to me that the critical element here is citizen involvement. Equality makes the equation balance easier, and makes the involvement more feasible (in terms of available personal resources, if nothing else). But a sufficient level of motivation and involvement in the political process will compensate for inequality to an extent, whereas equality, in and of itself, in the absence of a strong ethic of citizen involvement in government doesn't get you much (and probably doesn't last, either).
My sense is that a sustainable democratic political system will require a level of involvement from the average citizen that seems enormous by modern metrics (though perhaps not so large in absolute terms, since any involvement is much more than the current average of ~zero).
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MAD MAC Posted 6:18 pm
14 Oct 2008
Victory in Pattani
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Jon Rynn Posted 12:44 am
15 Oct 2008
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MAD MAC Posted 2:32 am
15 Oct 2008
Victory in Pattani
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HWilkes Posted 3:59 am
15 Oct 2008
One question I had was how effective would a strong program of anti-corruption be in terms of preventing regulatory capture? This would include items such as the following:
Forbidding or vastly limiting political donations-which ensures that whoever has the most money has the most access to the system regardless of whatever merits their position might or might not have.
Strengthening limitations on where someone from the government can work for a period of years after they leave government service, so it's harder for them to become lobbyists for hire by whoever has the most money.
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HWilkes Posted 4:01 am
15 Oct 2008
One question I had was how effective would a strong program of anti-corruption be in terms of preventing regulatory capture? This would include items such as the following:
Forbidding or vastly limiting political donations-which ensures that whoever has the most money has the most access to the system regardless of whatever merits their position might or might not have.
Strengthening limitations on where someone from the government can work for a period of years after they leave government service, so it's harder for them to become lobbyists for hire by whoever has the most money.
I also had an unrelated question I wanted to bring up here. I live in California and I haven't quite decided how to vote on a couple of propositions concerning green energy in the state. Does anyone have a good guide as to who is really funding them, or what they would actually do as compared to the euphemisms?
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Gar Lipow Posted 10:49 am
15 Oct 2008
1) Given everybody in the U.S. a one hundred dollar voucher during even (Federal) election years, they could divide up among any candidates they wish. During off year elections, people would get ten dollar vouchers if their were any state or local elections. You could raise the 30 billion dollars through a tax on advertising.
2)Elect Congress, state legislatures, councils and other legislative bodies and multi-member boards via proportional representation. Run executive elections (such as President, Governor and [usually] Mayor via choice voting, such as instant run-off or instant round-robin.
I think however that winning in the economic dimension (for example single payer health or massive Green investment) is more likely to build a coalition that can then go on to win this type of Goo-Goo stuff than that we can build a Goo-Goo coalition in the absence of a movement fighting around bread and butter issues.
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