What’s Next?

By John Baden, Chairman of the Foundation for Research on Economics & the Environment (FREE), based in Bozeman, MT.

In response to my recent column, “What Went Wrong,” several people emailed me this question: What’s next? The answer is easy; America will attempt to emulate Europe’s welfare state. Our perceived crisis is inimical to sound policy and provides a good seedbed for political opportunism.

First, though, a positive note. America can congratulate itself on successfully overcoming racial prejudice. Consider Obama’s enthusiastic reception at the University of Mississippi, a school where, in 1962, federal marshals were required to protect James Meredith when he was admitted to the Law School. Riots followed, and it took several regiments of U.S. Army troops to restore order and protect Meredith from harm. This election is a benchmark, genuine progress to celebrate. It’s as though we cured or, at the least, arrested a debilitating if not quite lethal cancer.

However significant this progress, and progress it surely is, 2008 may also mark the end of the great American experiment in individual liberty and responsibility. Attempts to activate the European welfare state in America will dominate politics for the foreseeable future. Here’s why.

Those who created the American experiment recognized the problem of constraining two kinds of bandits: the stationary and the mobile. Mobile bandits include highwaymen, pirates, common thieves, and muggers. These are conceptually easy to constrain; enlist honest police.

Stationary bandits are more difficult, and were a focus of America’s founders. Their challenge was to create a constitution to generate and maintain laws that foster progress-while constraining those making the laws.

How might those in power be kept from rigging the game to the advantage of themselves and their most politically powerful constituents?

Over the long run this may be impossible in a large democracy comprised of numerous factions, interest groups, and ethnic and racial identities. No such nation has successfully dealt with this challenge. It is easier in a small, relatively homogenous country, not one like ours.

The current worldwide financial crisis gives license to our stationary bandits to advantage themselves and powerful constituents. Franklin Raines, White House Budget Director under Clinton, became CEO of Fannie Mae and received $90 million in salary and bonuses. Of course Fannie Mae had made large and strategic concessions and donations to politicians. That’s how politics works.

America’s automakers, protected for years by tariffs from foreign competitors, are but one of numerous corporate examples of powerful firms, and unions, shaping the rules and seeking to loot taxpayers. Such pleading is bound to increase; the political tide is with those who see and seize opportunities for advantage, always, of course, in the “public interest.” The results are ominous and the causes clear.

First, there is diminishing support for institutions that generate wealth rather than redistribute it. Who still advocates small government, low taxes, private property, and the market process? It’s not a null, but surely a small, set of citizens-and few are among America’s opinion leaders and political decision makers. We elect those who promise us our share. This does not augur well for the survival of a wholesome America.

A second factor is the huge increase in the disparity in income between the top one-tenth of one percent of the population and the remainder. While Americans have been more tolerant of substantial wage and salary differences than Europeans, there is a cultural threshold that we’ve long since passed.

Who thinks a CEO is really worth $25 or $50 million or more per year? Few voters do and resentment builds. And consider our reactions to $10 million dollar vacation homes.

Third, both positive and negative values increasingly converge and agglutinate. This promotes substantial class differences. If one is blessed with responsible parents, intelligence, favorable genetics, health, presentable appearance, and the ability to defer gratification, she is exceeding likely to prosper-and to marry one with similar characteristics.

However, everyone has one vote. The political calculus is obvious and on bold display; promising voters public largess brings victory and dependency.

What’s next? A new and different America, one that will increasingly resemble the European welfare state. Some friends celebrate this anticipated change. Few however heed ecologists’ admonition and ask: “And then what?

What are predictable consequences of the proposed changes?” That’s a future column.

Unless noted otherwise, everything posted here is © 2009 Gregory R Jensen.

What Went Wrong?

As I have thought about the current economic world situation as well as some of the struggles facing the Orthodox Church in the United States, I have begun to wonder if there are not certain parallels.  Specifically, a shared lack of awareness of, or maybe indifference to, the human vocation to be wise stewards of the gifts we have been given by a loving and merciful God.

One thing that has helped me understand somewhat the struggles I see in the Church are the findings of a relatively new branch of the social sciences, the economic study of religion.  Applying economic theory, scholars in this discipline work to understand the different choices made in the area religion.

Now one of the different groups I am associated with is Foundation for Research on Economics & the Environment (FREE), based in Bozeman, MT and chaired by the author of the essay I have posted here today, John Baden. 

In some John’s earlier scholarship, he looked at how different religious political groups manage the stewardship of shared goods (the “tragedy of the commons“).  I thought I word re-post some of Dr Baden’s columns here to stimulate some conversation especially on the life of the Church.

As always, your comments, thoughts, questions and criticisms are not only welcome, they are actively sought.

In Christ,

+Fr Gregory

This column was prompted by the question: “Doesn¹t today’s economic distress demolish the case for capitalism and free markets?”

Some, who inquired gleefully, anticipated my discomfort; others were genuinely curious and concerned. All were confused about the complex causes of our economic chaos.

I hope this helps clarify their thinking, but first a disclaimer: I’m not a general economist who knows macroeconomics, money and banking, and international trade. Rather, I’m a retired professor and farmer who has studied and written academic articles and books on political economy for 40 years. I focus on the ways in which institutions, that is culture, ethical norms, and law, influence wealth, opportunities, and strategic behavior.

Let’s dismiss the claim that the greed of Wall Street and investment bankers caused our distress. Greed is ubiquitous, perhaps for evolutionary reasons. Jewish theologians have wrestled with this character flaw for three thousand years. Yet, Israeli politics remain plagued with pathological greed.

Blaming greed is like condemning gravity; both endure. Responsible people recognize and utilize these forces rather than deny them. It’s most constructive to design institutions that contain and direct greed into productive channels, just as engineers put gravity to use in building arches. Obviously, our institutions are flawed, greed has run amuck, and innocent as well as complicit folks are hurt.

Let’s first consider the basic function of capitalism. Its success lies in efficiently allocating capital toward profit, the difference between costs and returns. When the system works, market prices provide the information and the incentives to invest where legal returns are greatest.

But this is perhaps not capitalism’s greatest asset. In addition to being an engine of prosperity, only free markets spontaneously and peacefully organize the daily, voluntary interactions of millions of primarily self-interested individuals.

Socialism works poorly because it is unable to efficiently coordinate and allocate resources. Hence, it never generates wealth for the masses but socialist elites enjoy privilege and plenty. Their greed rigs the game to their advantage. Likewise, America’s investment bankers have rented and bribed politicians to rig the game to socialize risks and privatize profits. Fannie and Freddie’s failures and rich rewards to former managers, $100 million to one, are prime examples.

Our current problems flow largely from Wall Street bankers’ financial innovations. They discovered ways to profit by misallocating capital, and in the process they decoupled risk from their returns. Under legislation for which they lobbied, they were rewarded for pumping evermore capital into overvalued housing. Viewing their houses as ATMs, people bought consumer goods far beyond their means. (Expect massive credit card default next.)

Investment bankers arranged highly arcane financial instruments covering their loans with understated risks. Loans were bundled, sold internationally, and insured by American International Group (just bailed out with nearly $125 billion from the federal government) among others. This process endured as poor risk management was fostered by profits from capital misallocation.

Further, Wall Street adults who should have been in charge and responsible, didn’t understand the complex, mathematical models directing investment decisions. Senior management ignored the admonition to loan money only to those likely to pay it back.

While some bankers knew better, the net result of bad loans is the erosion of capital. Assuming recovery, we need institutional reforms that inhibit capital misallocation. For example, removing legal requirements to make loans when risks are not reflected in interest rates. This generates loss while stressing people, especially the poor.

When politicians allocate capital, we can’t expect efficiency, but corruption by special interests is certain. Investment banks benefited from this political arrangement. With the Bush Administration encouraging sub-prime lending (the “Ownership Society”), these home loans grew from 2 percent in 2002 to 30 percent in 2006. In October of 2004, President Bush said, “We’re creating…an ownership society in this country, where more Americans than ever will be able to open up their door where they live and say, welcome to my house, welcome to my piece of property.”

Sub-prime loans were bundled into Collateralized Debt Obligations and rated AAA. With this high rating, investment-banking firms neglected due diligence and sold the bundles worldwide. Defaults and massive write-offs naturally followed, banks collapsed, and we suffer.

That’s what went wrong.

John Baden is Chairman of the Foundation for Research on Economics & the Environment (FREE), based in Bozeman, MT.

Unless noted otherwise, everything posted here is © 2009 Gregory R Jensen.