Ethical Challenges of Finally Fixing the Financial Crisis: Fair Deals vs. New Deals
Below is an outline for my August 7, 2012 presentation at the Chautauqua Institution, Chautauqua, New York, earlier this week. Special thanks to Walker Todd of AIER for the invite and for creating this interesting program.
When someone asks about the ethical challenges of fixing the financial crisis, that question opens up multiple avenues of discussion. Everything about the breakdown in national trust since 2008 reflects a crisis of ethics. Ethics is the key question behind the entire event that we have now decided to call the financial crisis. Personal, institutional and national ethics all come into play in this search for supposed solutions. But in asking and then discussing this question, we may not necessarily reach the conclusion that at first seems so obvious to many Americans today – namely that the solution to the financial crisis is more laws and regulation.
I.
To start our conversation, let’s first define a couple of terms. First, fair dealing as a unique American concept. Second, the so-called “New Deal” of the 1930s. Economist Paul Krugman says that Americans need another New Deal, but it is my view that a fair deal consistent with traditional American values regarding politics and economics is a better idea. We’ll start with the New Deal and work backwards.
Harry Truman coined the political terms “fair deal” as an extension of FDR’s New Deal model. The basic idea of the New Deal was that government would guarantee economic opportunity and social stability. This model of political economy was distinctly European in derivation and is entirely at odds with the American traditions of limited government and individual responsibility. We still honor those traditional American values in a rhetorical sense, but in practical terms the operative model of American economic policy over the past century has become more and more socialist and European.
In the face of economic swings, labor unrest and geopolitical tensions following WWII, a large majority of Americans supported government intervention in all aspects of the economy. The shared experience with deflation and unemployment starting in the early 1900s and through WWI worked to make government intervention more and more popular. This was especially the case in urban areas where captive populations of immigrant workers became easy prey for progressive politicians promising a bigger piece of the economic pie.
Today, the chief ethic of America is not free enterprise or individual achievement, but dependency and transfer payments between the half of the households which pay taxes each year and the half which do not. The fact that the much maligned one percent pays a disproportionate percentage of the taxes each year goes largely unnoticed by politicians who seek to promote greater fairness in our society via government mandated redistribution of wealth. Yet each time that we raise taxes or increase government intervention in the shrinking private sector in the US, the net, net effect on individuals and the public at large seems to be negative.
The concept of a fair deal in America prior to the 20th Century was quite different than the politically opportunistic definitions coined by FDR and Truman. Truman saw the state as the mechanism for delivering economic and social stability, while the concept of “fair dealing” in the American sense implied a voluntary exchange between free individuals. The model behind the New Deal of FDR is authoritarian at its roots, while the fair dealing model of pre-20th Century America reflected a voluntary and democratic model of political economy. Citizens did the right thing because of a strong system of ethics, not because the coercive power of the state to punish nonconformity.
The founders of the United States were classics scholars and aware of the experiences of Rome and Greece when it comes to national governance. The views of anti-Federalists such as John Adams and Thomas Jefferson, for example, were very much consistent with the Greek view of democracy and economic life. Going back to the Greeks and Aristotle, notes Richard Day in “Globalization and Political Ethics,” the idea of an ethical society in a political and social sense was seen as paramount, while the pursuit of material or financial gain was secondary or even prohibited.
In the Nichomachean Ethics, Aristotle spoke of three types of economic exchange: 1) the natural, cooperative exchange of services in the form of good deeds among the members of society, 2) the natural form of exchange of things needed to satisfy household needs, and 3) the unnatural form of exchange of material goods, not to satisfy natural needs, but rather to take advantage of other people. Aristotle believed that money could be used as a medium for natural transactions, but that unnatural transactions motivated solely by the accumulation of money were evil and a threat to society.
In traditional American terms, “fair dealing” simply stated meant that both parties in the transaction received roughly equal value or utility. Consistent with the Aristotelian model of a just society, the two parties in a transaction had a duty to one another not to cheat and, indeed, to point out when the other party was making a mistake. The first two legs of the economic world defined by Aristotle were seen as acceptable, but financial speculation solely to earn a profit was anathema.
In much of America prior to the turn of the last century, the pursuit of financial gain was viewed as being socially unacceptable. If a daughter in 1900 came home and announced that she was betrothed to an investment banker, the reaction likely would have been disapproval. Since WWI, the idea of “investing” and financial speculation has gained progressively more and more acceptance with the public, in part because of the efforts by government to finance periodic wars and related domestic spending programs such as housing. The role of the federal government in subsidizing housing is the key cause of the financial crisis that began in 2008.
In place of the voluntary association between individuals that characterized the Greek polis and the US republic in the 19th Century, today Americans have created an authoritarian model of governance. The end result of the Civil War and American involvement in two world wars has been to make us a nation of laws rather than ethics. People are required to do the right thing in order to avoid punishment rather than choosing to do the right thing because of being a member of a virtuous and “fair” society. The roots of this social, ethic shift are ultimately financial, but finance driven by the imperative of war.
As the 20th Century began, a growing portion of the US population was concerned about the increasing concentration of wealth in society. The Robber Barons of the 19th Century were succeeded by the Money Trusts of the 20th century, vast predatory corporations with no duty to the idea of a virtuous society and, indeed, every incentive to do the wrong thing in pursuit of financial gain. Likewise, as the idea of speculation for its own sake grew in popularity, individuals increasingly rejected the traditional formulation of “fair dealing” in the American sense as well as the traditional, Aristotelian view of political economy that said financial speculation is inherently evil. Today we tolerate credit default swaps and other financial derivatives which have no connection to the real world of trade and commerce.
During the 1920s, as speculation in commodities, real estate and financial instruments reached a zenith and fraud likewise flourished, the federal government in Washington enacted a series of laws to restrict bad behavior. Both individuals and corporations were limited in their actions, in part because the public, courts and political class came to realize that the consensus regarding a civil society had broken down. Government regulation essentially became a substitute for virtue, both in terms of individual and corporate action in the economy. Most important, the pursuit of financial gain by individuals and companies was ratified as an acceptable form or behavior and one that could be regulated to avoid the bad results that so concerned Aristotle.
II.
So when we turn to crafting solutions to the crisis, the first questions seems to be whether more laws and regulations, and government subsidies, are the answer. If a society does not demand that people behave in an ethical and fair way in dealings with one another, what use are more laws? If current financial and economic pressures are so intense as to demand cheating as a means of survival, then how can regulation possibly help us to achieve a positive outcome? And if public policy encourages financial speculation, is there any way to make such activity “safe and sound?”
The results of regulation since the 1930s have been poor at best. You could argue that the period of 1950 through 2008 was one of relative stability. But as the size of government debt and intervention has grown to support that stability, so too has the specter of systemic risk. There is not a single instance in the post-WWII era where regulators were able to avoid a risk to the financial system. Fraud is only possible in a free society, after all, thus our democratic system works to enable financial bad acts. And regulators are just as susceptible to political pressures as are legislators and judges.
My former colleagues at the Fed, for example, worry that it is not possible for the largest banks to be resolved via an FDIC receivership. This causes so-called regulators to tolerate bad behavior by the largest banks that would cause the officers of smaller institutions to be indicted and imprisoned. The regulators are the facilitators of the acts of fraud committed by the big banks, presenting a stark illustration of the ethical roots of our collective financial woes.
Beyond the narrow question of regulation comes the economic premise of the New Deal. The cost of the New Deal and its iterations has been to burden the people of the US with debt that cannot be repaid and thus the prospect of future inflation. Zero interest rates today imply double digit or worse inflation in the future. No amount of regulation can make the current fiscal posture of the US government stable, either in terms of financial markets or future consumer and wholesale prices. Is it ethical for Congress and the Fed to steal money from savers via financial repression and inflation, deliberately designed to fund fiscal profligacy?
Federal Reserve Chairman Ben Bernanke said on Monday that gauging happiness can be as important for measuring economic progress as determining whether inflation is low or unemployment high. Economics isn't just about money and material benefits, Bernanke said. It is also about understanding and promoting "the enhancement of well-being."
This Orwellian nonsense from Chairman Bernanke illustrates the core, ethical dilemma of our time, namely that experts and regulators who are supposed to be working to achieve good outcomes for the public are instead apologists for bad policy. While we ponder imposing more regulation on private business, maybe instead we need to regulate the regulators and their sponsors in Congress. Perhaps imposing more ethical constraints on our elected officials is the first order of business.
The financial crisis presents us with an opportunity to reassess the ethical rules of our society. If you examine possible solutions to the crisis from the perspective of ethics, it is difficult not to conclude that the fiscal profligacy of the US government and related behavior in the private sector is the cause of the problem. Rather than imposing more constraints on individuals and private business via regulation, it might be more effective to place limitations on the ability of government to intervene in markets such as housing.
Thank you.