Life Is Unfair

Bryan watched Inside Job, while I am finally getting around to reading The Big Short by Michael Lewis, and I think it is undeniable that stupidity and cupidity on the part of banks and investment firms contributed to the recent financial disaster. A lot of libertarians squirm left and right to avoid admitting this, seeing it as a damning indictment of our laissez-faire message. Other libertarians are basically giving away the farm, conceding that we need massive regulation of the financial sector as well as countercyclical fiscal policy. (Hello, Richard Posner!)

As you have probably guessed, I do neither. Yes, the big banks, credit rating agencies, and investment firms acted with all the prudence of a gaggle of monkeys on meth, and yes, the resulting collapse has caused a lot of misery. But as that constant libertarian refrain reminds us, utopia is not an option. In the real world, people are always going to make mistakes, and sometimes the people making those mistakes will be in important positions and thus will be able to make important mistakes. What's worse, other people will sometimes suffer for those mistakes. Why is this? Here's my answer.





Yes, the circle of life does move us all, and sometimes it moves us into the trailer park. But why can't we protect people from this particular part of that endless round? Why can't we use the government to prevent these wicked Wall Streeters from doing these stupid things in the first place? Two (related) reasons:

1) As Michael Lewis makes clear in his book, and has been made clear in many other accounts of the Great Recession, the world of high finance is small and incestuous. The people competent to regulate these firms are usually former and future employees of the same firms. Naturally this dynamic leaves the industry especially prone to regulatory capture, rendering attempts at regulation ineffective. (Incidentally, the offshore petroleum industry, to which I have substantial family ties, has the same dynamic in play, as do all highly lucrative, highly technical fields, I suspect.)

2) Money is power. If regulatory capture is the specific, this principle is the general. Always and everywhere governments have been, are and always will be more responsive to the wishes of the wealthy than to those of the poor. Expecting the government to stop rich people (here, financiers) from doing something they desperately want to do (find new ways to make gobs of money on the capital markets) is, over the long term, a fool's hope. Besides, some of those new ways are actually good ideas. I am not enough of an expert on capital markets to name a recent innovation that has worked out well (Whip Lash, can you?), but Thales of Miletus, inventor of the futures contract (his was in olive oil), was one of humanity's greatest benefactors.

But surely we can overcome these things, right? Surely it's just a matter of the right policy. The whole history of the progressive movement in the United States, from Reconstruction to today, can be written as an endless quest to find that policy, with each iteration blowing up in their faces. From the 14th Amendment being used to strike down state regulation of corporations and the Sherman Anti-Trust Act used in union busting to Social Security transforming into a giant transfer from the poor to the wealthy and Medicare sending health care costs through the roof, again and again we have tried to design the right policy and again and again we have failed. Why? I am sure my readers know why, or at least know what I am going to say: information is decentralized, people respond to incentives, and making predictions is hard, especially about the future.

In short, we cannot regulate away the consequences of stupidity for two reasons, one epistemic and one historical. Epistemically, we cannot know the consequences of future attempts at regulation and historically, we know that government is the handmaiden of wealth. New regulations will create new, unforeseeable problems, and an empowered government will always serve its master. The latter reality overwhelms the Popperian ideal of piecemeal social engineering- however piecemeal, however painstaking, methodical, results-oriented, and iterative our policy-making is, the faithful hound will always return to his owner, and thus each new policy, however well-designed, will be either subverted or overthrown outright if it prevents government from serving its master.

Ways to mitigate these consequences, however, do exist. And they will await another post! But here is a sneak preview of my answer to Too Big To Fail: