The looting of America


The Looting of America’s Coffers
New York Times, 2009-03-11

[Emphasis is added.]

Sixteen years ago,
two economists published a research paper with a delightfully simple title:
Looting [: The Economic Underworld of Bankruptcy for Profit].”
[web references]

The economists were
George Akerlof, who would later win a Nobel Prize, and
Paul Romer, the renowned expert on economic growth.
In the paper, they argued that
several financial crises in the 1980s, like the Texas real estate bust,
had been the result of
private investors taking advantage of the government.
The investors had
  1. borrowed huge amounts of money,

  2. made big profits when times were good,
    and then

  3. left the government holding the bag
    for their eventual (and predictable) losses.

In a word, the investors looted.
Someone trying to make an honest profit,
Professors Akerlof and Romer said,
would have operated in a completely different manner.
The investors displayed
a “total disregard for even the most basic principles of lending,”
failing to verify standard information about their borrowers
or, in some cases, even to ask for that information.

The investors “acted as if future losses were somebody else’s problem,”
the economists wrote.
“They were right.”

On Tuesday morning in Washington,
Ben Bernanke, the Federal Reserve chairman,
gave a speech that read like a sad coda to the “Looting” paper.
Because the government is unwilling to let big, interconnected financial firms fail
— and because people at those firms knew it —
they engaged in what Mr. Bernanke called “excessive risk-taking.”
To prevent such problems in the future, he called for tougher regulation.

it would have been nice if the Fed had shown some of this regulatory zeal
before the worst financial crisis since the Great Depression.
But that day has passed.
So people are rightly starting to think about building
a new, less vulnerable financial system.

And “Looting” provides a really useful framework.
The paper’s message is that

the promise of government bailouts
isn’t merely one aspect of the problem.
It is the core problem.

Promised bailouts mean that anyone lending money to Wall Street —
ranging from small-time savers like you and me to the Chinese government —
doesn’t have to worry about losing that money.
The United States Treasury (which, in the end, is also you and me)
will cover the losses.
In fact, it has to cover the losses,
to prevent a cascade of worldwide losses and panic
that would make today’s crisis look tame.

[That’s the party line anyhow.]

But the knowledge among lenders that
their money will ultimately be returned, no matter what,
clearly brings a terrible downside.
It keeps the lenders from asking tough questions about
how their money is being used.
Looters —
savings and loans and Texas developers in the 1980s;
the American International Group, Citigroup, Fannie Mae and the rest
in this decade —
can then act as if their future losses are indeed somebody else’s problem.

Do you remember the mea culpa
that Alan Greenspan, Mr. Bernanke’s predecessor,
delivered on Capitol Hill last fall?
He said that he was “in a state of shocked disbelief” that
“the self-interest” of Wall Street bankers hadn’t prevented this mess.

He shouldn’t have been.
The looting theory explains why his laissez-faire theory didn’t hold up.
The bankers were acting in their self-interest, after all.

The term that’s used to describe this general problem, of course, is
moral hazard.
When people are protected from the consequences of risky behavior,
they behave in a pretty risky fashion.
Bankers can make long-shot investments,
knowing that they will keep the profits if they succeed,
while the taxpayers will cover the losses.

[By the way, this same reasoning explains why
making the general public,
through either health insurance or government services,
provide treatment for victims of AIDS,
gives reckless people effectively the license to engage in high-risk behavior.
Even if they get AIDS, someone else will pay for their treatment.]

This form of moral hazard —
when profits are privatized and losses are socialized —
certainly played a role in creating the current mess.
[In the case of AIDS, we would say
when pleasure is privatized and costs are socialized.]

But when I spoke with Mr. Romer on Tuesday,
he was careful to make a distinction between classic moral hazard and looting.
It’s an important distinction.

With moral hazard, bankers are making real wagers.
If those wagers pay off, the government has no role in the transaction.
With looting, the government’s involvement is crucial to the whole enterprise.

Think about the so-called liars’ loans from recent years:
like those Texas real estate loans from the 1980s,
they never had a chance of paying off.
Sure, they would deliver big profits for a while,
so long as the bubble kept inflating.
But when they inevitably imploded, the losses would overwhelm the gains.
As Gretchen Morgenson has reported,
Merrill Lynch’s losses from the last two years
wiped out its profits from the previous decade.

What happened?
Banks borrowed money from lenders around the world.
The bankers then kept a big chunk of that money for themselves,
calling it “management fees” or “performance bonuses.”
Once the investments were exposed as hopeless,
the lenders — ordinary savers, foreign countries, other banks, you name it —
were repaid with government bailouts.

In effect,
the bankers had siphoned off this bailout money in advance,
years before the government had spent it.

I understand this chain of events sounds a bit like a conspiracy.
And in some cases, it surely was.
Some A.I.G. employees, to take one example, had to have understood
what their credit derivative division in London was doing.
But more innocent optimism probably played a role, too.
The human mind has a tremendous ability to rationalize,
and the possibility of making millions of dollars
invites some hard-core rationalization.

Either way, the bottom line is the same:
given an incentive to loot, Wall Street did so.

“If you think of the financial system as a whole,”
Mr. Romer said,
“it actually has an incentive to trigger the rare occasions in which
tens or hundreds of billions of dollars come flowing out of the Treasury.”

Unfortunately, we can’t very well stop the flow of that money now.
The bankers have already walked away with their profits
(though many more of them deserve a subpoena to a Congressional hearing room).
Allowing A.I.G. to collapse, out of spite, could cause
a financial shock bigger than the one that followed the collapse of Lehman Brothers.
[The party line, again.]
Modern economies can’t function without credit,
which means the financial system needs to be bailed out.

But the future also requires
the kind of overhaul that Mr. Bernanke has begun to sketch out.
Firms will have to be monitored much more seriously
than they were during the Greenspan era.
They can’t be allowed to shop around for
the regulatory agency that least understands what they’re doing.
The biggest Wall Street paydays should be held in escrow
until it’s clear they weren’t based on fictional profits.

Above all, as Mr. Romer says,
the federal government needs the power and the will to take over a firm
as soon as its potential losses exceed its assets.
Anything short of that is an invitation to loot.

Mr. Bernanke actually took a step in this direction on Tuesday.
He said the government “needs improved tools to allow
the orderly resolution of a systemically important nonbank financial firm.”
In layman’s terms, he was asking for a clearer legal path to nationalization.

At a time like this, when trust in financial markets is so scant,
it may be hard to imagine that looting will ever be a problem again.
But it will be.
If we don’t get rid of the incentive to loot,
the only question is what form the next round of looting will take.

Mr. Akerlof and Mr. Romer finished writing their paper in the early 1990s,
when the economy was still suffering a hangover from the excesses of the 1980s.
But Mr. Akerlof told Mr. Romer —
a skeptical Mr. Romer, as he acknowledged with a laugh on Tuesday —
that the next candidate for looting already seemed to be taking shape.

It was an obscure little market called credit derivatives.

The virtues of public anger and the need for more
by Glenn Greenwald
Salon.com, 2009-03-21

[Its beginning; some of the emphasis is added.]

With lightning speed and lockstep unanimity, opinion-making elites
jointly embraced and are now delivering the same message
about the public rage triggered this week by the AIG bonus scandal:
This scandal is insignificant.
It’s just a distraction.
And, most important of all, public anger is unhelpful
and must be contained or, failing that, ignored.

This anti-anger consensus among our political [sic: media] elites is exactly wrong.
The public rage we’re finally seeing is long, long overdue, and
appears to be the only force with both the ability and will
to impose meaningful checks on
continued kleptocratic pillaging and deep-seated corruption

in virtually every branch of our establishment institutions.
The worst possible thing that could happen now
is for this collective rage to subside
and for the public to return to its long-standing state of blissful ignorance
over what the establishment is actually doing.

It makes perfect sense that
those who are satisfied with the prevailing order --
because it rewards them in numerous ways --
are desperate to pacify public fury.
Thus we find unanimous decrees that public calm (i.e., quiet) be restored.
It’s a universal dynamic that
elites want to keep the masses in a state of silent, disengaged submission,
all the better if the masses stay convinced that
the elites have their best interests at heart
and their welfare is therefore advanced by allowing elites -- the Experts --
to work in peace on our pressing problems,
undisrupted and “undistracted”
by the need to placate primitive public sentiments.

While that framework is arguably reasonable
where the establishment class is competent, honest, and restrained,
what we have had -- and have --
is exactly the opposite:
a political class and financial elite
that is rotted to the core and running amok.
We’ve had far too little public rage
given the magnitude of this rot, not an excess of rage.
What has been missing more than anything else is this:
fear on the part of the political and financial class
of the public which they have been systematically defrauding and destroying.


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