Insights from watching PBS Frontline video, Inside the Meltdown: What happend to the economy?
I sent the following article to Huffington Post, but got no response, so I'm posting it here....
January 25, 2010
This article was inspired by a PBS Frontline video called "Inside the Meltdown: What happened to the economy?", which did a superb job of documenting (as of February, 2009) exactly what happened during the financial collapse, and the subsequent government bailout at the end of 2008. (You can watch this hour-long show at www.pbs.org.)
Public opinion has gradually shifted to what appears to be a fairly widespread consensus that "We the People" got royally screwed by the big financial institutions in the bailout. What I discovered watching the story of how this financial cataclysm happened, however, was that I could catch just a glimpse of the outlines of a real solution to the underlying problems in our economic system, and I'd like to share those glimpses with your readers.
I'll start by pointing out that my insights revolve around a concept central in the mind of Henry Paulson, the Secretary of the U.S.Treasury Department who essentially engineered, together with Ben Bernanke, the Federal Reserve Chairman, the (so far) successful resurrection of the collapsed U.S. (and consequently global) economic system. The concept is Moral Hazard. It is explained in the film as a belief, held strongly by those most successful and powerful in the existing system, and especially Paulson, that if you bail someone out from a situation which they themselves caused, then they will have no incentive to recognize their mistakes, and so will likely do the same erroneous or even malevolent things again.
In some contexts, this idea is clearly right. Suppose a person, call him Ishmael, has a gripe (real or imagined) with his brother Isaac. Instead of discussing the problem, or submitting the problem to arbitration by others, Ishmael decides the best thing for him to do is to spend all his money, everything he owns, to hire a hit-man to kill Isaac. But suppose the hit-man fails, is captured, and thrown in jail. Now Ishmael is in desperate trouble because he has nothing, and no way to support himself. The doctrine of Moral Hazard says that it would be wrong to bail Ishmael out of his desperation, since he would then have no incentive to do anything other than what he did before: he takes your bailout money, hires another hit-man, etc. In other words, because Ishmael is bailed out of a situation he himself caused, he has no chance to learn from his mistakes, which, as Buckminster Fuller points out, is the way humans have always learned about the nature of the world they live in, starting from the moment of their birth. And so, it is clear that to deprive Ishmael of the opportunity to learn from his mistakes is an extraordinary "moral" crime, because it robs him of what might be viewed as the essence of his humanity... (not to mention the fact that it keeps Isaac dodging bullets).
We learn in the video that it was extremely clear to Paulson that a government bailout of Bear Stearns would be a classic case of Moral Hazard. Nonetheless, Paulson & Bernanke decided that there were other considerations that had to take precedent over the Moral Hazard issue: the possibility of an economic systemic failure, i.e., a meltdown. And so, when announcing the bailout of Bear Stearns, Paulson sent a stern warning to Wall Street that there would be no further bailouts by the government (to which the other brokerages replied, "Yea, right.").
When Lehman Brothers showed up at the Treasury a short time later asking for a similar bailout, Paulson and Bernanke were faced with a moment of truth. These two immensely successful men, standing at the pinnacle of the financial edifice, were the acknowledged masters of the game, and now they were confronted by not only the hardest choice of their careers, but by a question that put at risk the very foundations of the global economic system, and potentially threatened the lives of millions... even billions of people on planet earth. That question was whether the doctrine of Moral Hazard, upon which the existing free market global economy is based, is in fact a red herring when applied to the global economy of 2009. In other words, they had to consider the possibility that Moral Hazard may well be valuable for handling Ishmael's rage, but of no use whatsoever in guiding corporate and government behavior in a global economy.
Paulson's answer was clear and concise: to remove the Moral Hazard beacon from the helm would be equivalent to removing the rudder from the ship of the American economy: it would become unsteerable. Paulson was willing to risk the systemic repercussions of letting Lehman Brothers fail. And it did.
This brings us to the insight which I believe is the crucial lesson of the economic meltdown, and it is simply the lesson which Henry Paulson was forced to learn from his mistake in letting Lehman Brothers fail. For it was no doubt a mistake. After Lehman's bankruptcy was followed by the failure and subsequent government buyout of Fannie Mae & Freddie Mac, all confidence evaporated from Wall Street and credit froze. Then suddenly the insurance giant AIG turned to the Treasury and the Fed for help, because it was no longer able to meet its payment obligations, because it now owed billions of dollars which it did not have on "credit default swaps" insuring companies across the globe against the failure of Lehman brothers, which had now failed. Since all the big financial brokerages and banks were now vulnerable, for they all held the same "toxic debt", and they were all interdependent in their relations with each other, Paulson & Bernanke realized they had to address the systemic failure which was unfolding before their eyes. And it was clear they had to act fast, before every security, every mutual fund, every insurance policy, every annuity and pension, and every bank deposit (over FDIC insured amount of $100K) became approximately worthless.
Within days Paulson & Bernanke had discarded the doctrine of Moral Hazard along with the entire foundation of conservative unregulated free-market capitalism upon which they had built their enormous success, their fortunes and their reputations. They turned to congress for bailout money, at first asking for $700 billion to buy the "'toxic mortgages" supposed to be causing the problem, but soon changing the strategy to the "capital injection" of billions --soon to be trillions-- into the largest banks to stop the immanent collapse of the financial system.
Capital injection, of course, is a guaranteed income for corporations, not for people. Which means that the bailout was a guaranteed income for the shareholders of these corporations, as well as for all those who would have lost everything without the bailout which Congress approved.
Personally, I consider Paulson & Bernanke to be heros. Not because they've solved the financial crisis, because they haven't. But because, standing at the pinnacle of success, rather than defending their own deeply-held principles, which they could easily have done, they had the courage to embrace their humanness and recognize the consequences of their decision upon all of humanity, and so humbled themselves by admitting that the fundamental principle upon which our entire economic system today is based, is a mistake.
The doctrine of Moral Hazard cannot guide the global economy in the twenty-first century. It is time for all of us to join the discussion, so that we can quickly find the best answer to the question of what can.
Finally, I will end with my answer to this question. It is a vision of a "Permanent Status" solution for the American economy which could serve as a global model. When Paulson & Bernanke made the decision to allow Lehman Brothers to fail, every stock, bond, mutual fund, insurance policy, annuity, pension and large bank account became, at that moment, approximately worthless. When they changed their minds and went to Congress asking for an initial $700 billion to "unfreeze the credit markets", to be followed by 10 trillion or more in subsequent bailouts, this was in effect a "Guaranteed Income" for stockholders. It is an indisputable fact that those millions of stockholders, who own the lion's share of wealth in the U.S. and the world, are today not penniless on the streets because the U.S. government gave them a guaranteed income. There is now a serious question of fairness ... of justice ... in the government giving blanket guaranteed incomes to the wealthiest citizens (without the filling out of 6-page fine-print forms requiring disclosure of their personal circumstances and all sources of income over $25, such as those required of Food Stamp recipients), while that same government ignores the needs of the homeless living -- and dying -- on the streets, not to mention the millions struggling for mere subsistence.
In my view, the government should do nothing for anyone that it is not willing to do for everyone.
I propose that the permanent solution to the global financial crisis we are still dealing with can be achieved by replacing the United States Tax Code with a simple system to implement a Guaranteed Income for all. Each year each citizen would be allowed to choose which of two tax-brackets they would like to have apply to themselves. In the first bracket, you pay a flat 25% tax on any income you have over $100,000. In the second bracket, you pay a flat 50% tax on any income earned other than the $2,000 per month that you receive from the government, which can be called a tax credit, a negative income-tax payment, or a guaranteed income.
The concept of a guaranteed income is not mine. It has been explained and supported, in various forms, by a long list of notables, including Thomas Jefferson, Thomas Paine, Abraham Lincoln and many others (see the full list at www.incomesecurityforall.org). But perhaps most significantly, in the 1960s, economists Milton Friedman, Robert Theobald, and John Kenneth Galbraith articulated a practical guaranteed income plan and advocated its adoption by Congress , as did the one man who worked out the "Critical Path" by which humanity could avoid destroying itself and create a world that worked for everyone: R. Buckminster Fuller. In a speech delivered in Atlanta, Georgia on August 16, 1967, entitled "Where do we go from here: chaos or community?", Dr. Martin Luther King, Jr. announced that he had come to the conclusion that the quickest and most efficient way to end poverty in our time was to adopt a guaranteed income program.
The principal objection raised by those who oppose implementing a guaranteed income program is the doctrine of Moral Hazard.
.
January 25, 2010
This article was inspired by a PBS Frontline video called "Inside the Meltdown: What happened to the economy?", which did a superb job of documenting (as of February, 2009) exactly what happened during the financial collapse, and the subsequent government bailout at the end of 2008. (You can watch this hour-long show at www.pbs.org.)
Public opinion has gradually shifted to what appears to be a fairly widespread consensus that "We the People" got royally screwed by the big financial institutions in the bailout. What I discovered watching the story of how this financial cataclysm happened, however, was that I could catch just a glimpse of the outlines of a real solution to the underlying problems in our economic system, and I'd like to share those glimpses with your readers.
I'll start by pointing out that my insights revolve around a concept central in the mind of Henry Paulson, the Secretary of the U.S.Treasury Department who essentially engineered, together with Ben Bernanke, the Federal Reserve Chairman, the (so far) successful resurrection of the collapsed U.S. (and consequently global) economic system. The concept is Moral Hazard. It is explained in the film as a belief, held strongly by those most successful and powerful in the existing system, and especially Paulson, that if you bail someone out from a situation which they themselves caused, then they will have no incentive to recognize their mistakes, and so will likely do the same erroneous or even malevolent things again.
In some contexts, this idea is clearly right. Suppose a person, call him Ishmael, has a gripe (real or imagined) with his brother Isaac. Instead of discussing the problem, or submitting the problem to arbitration by others, Ishmael decides the best thing for him to do is to spend all his money, everything he owns, to hire a hit-man to kill Isaac. But suppose the hit-man fails, is captured, and thrown in jail. Now Ishmael is in desperate trouble because he has nothing, and no way to support himself. The doctrine of Moral Hazard says that it would be wrong to bail Ishmael out of his desperation, since he would then have no incentive to do anything other than what he did before: he takes your bailout money, hires another hit-man, etc. In other words, because Ishmael is bailed out of a situation he himself caused, he has no chance to learn from his mistakes, which, as Buckminster Fuller points out, is the way humans have always learned about the nature of the world they live in, starting from the moment of their birth. And so, it is clear that to deprive Ishmael of the opportunity to learn from his mistakes is an extraordinary "moral" crime, because it robs him of what might be viewed as the essence of his humanity... (not to mention the fact that it keeps Isaac dodging bullets).
We learn in the video that it was extremely clear to Paulson that a government bailout of Bear Stearns would be a classic case of Moral Hazard. Nonetheless, Paulson & Bernanke decided that there were other considerations that had to take precedent over the Moral Hazard issue: the possibility of an economic systemic failure, i.e., a meltdown. And so, when announcing the bailout of Bear Stearns, Paulson sent a stern warning to Wall Street that there would be no further bailouts by the government (to which the other brokerages replied, "Yea, right.").
When Lehman Brothers showed up at the Treasury a short time later asking for a similar bailout, Paulson and Bernanke were faced with a moment of truth. These two immensely successful men, standing at the pinnacle of the financial edifice, were the acknowledged masters of the game, and now they were confronted by not only the hardest choice of their careers, but by a question that put at risk the very foundations of the global economic system, and potentially threatened the lives of millions... even billions of people on planet earth. That question was whether the doctrine of Moral Hazard, upon which the existing free market global economy is based, is in fact a red herring when applied to the global economy of 2009. In other words, they had to consider the possibility that Moral Hazard may well be valuable for handling Ishmael's rage, but of no use whatsoever in guiding corporate and government behavior in a global economy.
Paulson's answer was clear and concise: to remove the Moral Hazard beacon from the helm would be equivalent to removing the rudder from the ship of the American economy: it would become unsteerable. Paulson was willing to risk the systemic repercussions of letting Lehman Brothers fail. And it did.
This brings us to the insight which I believe is the crucial lesson of the economic meltdown, and it is simply the lesson which Henry Paulson was forced to learn from his mistake in letting Lehman Brothers fail. For it was no doubt a mistake. After Lehman's bankruptcy was followed by the failure and subsequent government buyout of Fannie Mae & Freddie Mac, all confidence evaporated from Wall Street and credit froze. Then suddenly the insurance giant AIG turned to the Treasury and the Fed for help, because it was no longer able to meet its payment obligations, because it now owed billions of dollars which it did not have on "credit default swaps" insuring companies across the globe against the failure of Lehman brothers, which had now failed. Since all the big financial brokerages and banks were now vulnerable, for they all held the same "toxic debt", and they were all interdependent in their relations with each other, Paulson & Bernanke realized they had to address the systemic failure which was unfolding before their eyes. And it was clear they had to act fast, before every security, every mutual fund, every insurance policy, every annuity and pension, and every bank deposit (over FDIC insured amount of $100K) became approximately worthless.
Within days Paulson & Bernanke had discarded the doctrine of Moral Hazard along with the entire foundation of conservative unregulated free-market capitalism upon which they had built their enormous success, their fortunes and their reputations. They turned to congress for bailout money, at first asking for $700 billion to buy the "'toxic mortgages" supposed to be causing the problem, but soon changing the strategy to the "capital injection" of billions --soon to be trillions-- into the largest banks to stop the immanent collapse of the financial system.
Capital injection, of course, is a guaranteed income for corporations, not for people. Which means that the bailout was a guaranteed income for the shareholders of these corporations, as well as for all those who would have lost everything without the bailout which Congress approved.
Personally, I consider Paulson & Bernanke to be heros. Not because they've solved the financial crisis, because they haven't. But because, standing at the pinnacle of success, rather than defending their own deeply-held principles, which they could easily have done, they had the courage to embrace their humanness and recognize the consequences of their decision upon all of humanity, and so humbled themselves by admitting that the fundamental principle upon which our entire economic system today is based, is a mistake.
The doctrine of Moral Hazard cannot guide the global economy in the twenty-first century. It is time for all of us to join the discussion, so that we can quickly find the best answer to the question of what can.
Finally, I will end with my answer to this question. It is a vision of a "Permanent Status" solution for the American economy which could serve as a global model. When Paulson & Bernanke made the decision to allow Lehman Brothers to fail, every stock, bond, mutual fund, insurance policy, annuity, pension and large bank account became, at that moment, approximately worthless. When they changed their minds and went to Congress asking for an initial $700 billion to "unfreeze the credit markets", to be followed by 10 trillion or more in subsequent bailouts, this was in effect a "Guaranteed Income" for stockholders. It is an indisputable fact that those millions of stockholders, who own the lion's share of wealth in the U.S. and the world, are today not penniless on the streets because the U.S. government gave them a guaranteed income. There is now a serious question of fairness ... of justice ... in the government giving blanket guaranteed incomes to the wealthiest citizens (without the filling out of 6-page fine-print forms requiring disclosure of their personal circumstances and all sources of income over $25, such as those required of Food Stamp recipients), while that same government ignores the needs of the homeless living -- and dying -- on the streets, not to mention the millions struggling for mere subsistence.
In my view, the government should do nothing for anyone that it is not willing to do for everyone.
I propose that the permanent solution to the global financial crisis we are still dealing with can be achieved by replacing the United States Tax Code with a simple system to implement a Guaranteed Income for all. Each year each citizen would be allowed to choose which of two tax-brackets they would like to have apply to themselves. In the first bracket, you pay a flat 25% tax on any income you have over $100,000. In the second bracket, you pay a flat 50% tax on any income earned other than the $2,000 per month that you receive from the government, which can be called a tax credit, a negative income-tax payment, or a guaranteed income.
The concept of a guaranteed income is not mine. It has been explained and supported, in various forms, by a long list of notables, including Thomas Jefferson, Thomas Paine, Abraham Lincoln and many others (see the full list at www.incomesecurityforall.org). But perhaps most significantly, in the 1960s, economists Milton Friedman, Robert Theobald, and John Kenneth Galbraith articulated a practical guaranteed income plan and advocated its adoption by Congress , as did the one man who worked out the "Critical Path" by which humanity could avoid destroying itself and create a world that worked for everyone: R. Buckminster Fuller. In a speech delivered in Atlanta, Georgia on August 16, 1967, entitled "Where do we go from here: chaos or community?", Dr. Martin Luther King, Jr. announced that he had come to the conclusion that the quickest and most efficient way to end poverty in our time was to adopt a guaranteed income program.
The principal objection raised by those who oppose implementing a guaranteed income program is the doctrine of Moral Hazard.
.
posted by Loren Of Lorien | 10:45 PM
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