The taxpayers’ burden

December 4, 2011

The author is a Reuters columnist. The opinions expressed are his own.

Taxpayers have much at risk in the coordinated action that six central banks took this week to lower short-term interest rates and make it easier to issue dollar-denominated loans to cope with the European debt crisis.

The joint action on the last day of November is being characterized widely as buying time to deal with the European government debt crisis. But fears about whether the PIGS — Portugal, Italy, Greece and Spain — can pay back their debts in full are just a symptom of a metastasizing economic disease that has been plaguing the West for three decades. That is where the risks to taxpayers come in.

The disease was man-made, a policy virus cooked up by the Chicago School, where leading theorists persuaded the world to cast aside four millennia of human experience in favor of their radical legal and economic ideas. They have achieved this by couching their plans in language that made them seem conservative when the theories were the antithesis of conservative, at least in the classic meaning of that word.

Among these ideas is that inflation is everywhere a government-created evil that must be fought at all costs, that financial institutions operate best with little to no regulation and that fraud laws are an anachronism in securities markets. In line with this, deflationary pressures are ignored and prudent investment houses become casinos charging hefty fees for derivatives that by their nature destroy wealth while frauds flourish in the form of mortgage securities perpetrated by banks and Wall Street.

The damage is now done. The price must be paid.


Who bears this price will determine whether we face the scary risk of inflation or the even scarier prospect of deflation. Will those who benefited from these policies bear the price? Or, as with the 2008 U.S. financial meltdown, will it be taxpayers?

To understand the damage from the idea that regulation is bad and no regulation is good, one need only look at the data analyzed by David Moss, a Harvard Business School professor. Moss’s research persuaded him that regulations should be minimal — except for financial companies because of the damage they can cause.

The accompanying graphic shows a fascinating correlation. In the years before New Deal regulation of banks and after the easing of regulations began in 1980, bank failures were quite high. So was income inequality.

But from about 1933, when the federal regulation of banks was put in place, to 1980, when Chicago School theories began to shape policy, bank failures were rare. During those years incomes were much more equal, with a prosperous middle class.

Moss notes that critics denounced as a moral hazard the creation of the Federal Deposit Insurance Corp for banks, and similar insurance for other financial institutions, nearly eight decades ago. Knowing the insurance would protect depositors, the critics said, would encourage loose lending practices and leave taxpayers stuck with the costs, an idea still in vogue at the Chicago School when I studied there in 1973.

But, in fact, the opposite occurred. Many bank failures would have meant high insurance premiums, but strict regulation kept failures minimal, lowering costs while giving bankers an incentive to be prudent. That is not part of the anti-regulation Chicago dogma.


Correlation is not causality, but the fact that income inequality rose as banking regulations were eased makes sense. Freed of restraints, banks got into all sorts of activities that generated fees and saddled clients with high-interest debt. And once banks could collect fees for mortgages without having to worry about repayment — because the mortgages were sold off by Wall Street — the crucial link between reward and responsibility was severed.

With loosened financial regulation it would seem smart to increase law enforcement. Instead, enforcement was cut, as the chart from Syracuse University’s Transactional Records Access Clearinghouse shows. Based on Justice Department internal reports, it shows criminal prosecutions involving financial firms down sharply since fiscal 1999.

These findings about bank failures, income inequality and lack of prosecutions all take us back to the coordinated attempt by the central banks of the United States, Britain, Canada, the European Union, Japan and Switzerland to delay the day of reckoning on European debt.

Central banks can artificially set short-term interest rates, inject liquidity and acquire worthless assets pretty much forever if they deal in their own currency. No sovereign with monopoly control of its currency, as each of these jurisdictions has, can go broke in its own currency.

But that doesn’t mean the price of imprudence has been reduced to zero. Creditors or borrowers must suffer the costs of unsound lending. They should not be allowed to shift that cost onto taxpayers. Given the revolving doors that allow the financial class to move smoothly between government, central banks and financial firms throughout the modern world, and how those in power in all of these places have invested their reputations in Chicago School theories, my educated guess is that taxpayers will be stuck with the costs. Let’s hope I am wrong.


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A fine, insightful analysis. And, in the, end, I hope you’re wrong too (but I expect as you expect.)

Posted by OneOfTheSheep | Report as abusive

Thank you for this piece. Papering over a solvency crisis with liquidity bites the middle class, I think this is something the Germans understand.

Posted by shrink2 | Report as abusive

Future taxpayers may bear this burden – current taxpayers do not. Tax revenue has fallen during the crisis and governments have relied on borrowing and the printing press rather than tax revenue to finance the recovery. At some point the minority of taxpayers who produce more tax revenue than the cost of the government services that they consume will be on the hook to repay the eventual cost. Correlation is not causality; but check the graph where the share of US income for the top 10% plunges – 1941/45 when there was a big war to pay for. After the war, the top 10% were still doing well compared to their bombed out counterparts in other major economies. How much has the ratio between the income of the CEOs of Ford, Volkswagen and Toyota changed since 1945?

Posted by walstir | Report as abusive

So…we should all vote Democratic? Because they’re the party of the “people”?

Posted by scarr34 | Report as abusive


Please tell me that is not your only take away from this piece. What you are implying is correct though, modern day Conservatives/Republicans have little principles left and their hypocrisy has no bounds.

Newt Gingrich is another prime example. Newt made between $1.6 million and $1.8 million in consulting fees from two Freddie Mac contracts.

“Political corruption undoubtedly played a huge role in the collapse of Freddie Mac and its counterpart Fannie Mae, which has left U.S. taxpayers potentially on the hook for trillions of dollars. In 2009 Judicial Watch obtained internal government documents proving that members of Congress (such as the disgraceful Barney Frank) were well aware that Fannie and Freddie were in deep trouble due to corruption and incompetence and yet they did nothing to stop it. JW continues pursuing Freddie and Fannie records but the Obama Administration (the most transparent in history?) engaged in a legal battle to keep each and every one them secret. Ironically, President Obama, the man who Gingrich is seeking to oust from office, is keeping secret public documents that could shed light on Gingrich’s relationship with Freddie.”

Yet Newt is now in the lead for the Republican nomination. The voters have put on their uniforms, pulled out the pom poms and turned off their minds. Much easier to cheer than to spend time to look at the facts and the context and see what’s right in front of you.

That being said Glass-Steagall was repealed under Bill Clinton. Democrats have done their part. He is loved on Wall Street still. Alan Greenspan’s tenure was spread across administrations. Economic teams too have been handed down. Greenspan was once considered a god who fervently ascribed to deregulation and also felt that fraud needn’t be investigated. How far he has fallen. The damage he is responsible for is immeasurable. He is not alone.

This was a good Frontline piece:

So I would say not to simply vote for anyone. Instead, it’s time we stop fighting with each other and look at the facts, the context. It’s time to demand accountability from all party’s. It’s time to put away the uniforms, stop the cheering and the coddling of our leadership simply because they’re wearing our colors/uniform.

Posted by TheUSofA | Report as abusive

The damage is now done. The price must be paid.

The answer is simple, anyone but those who caused the damage to being with. This is capitalism today. Those who made the risky bets have diverted the risk to others: taxpayers or the general public who holds currency. The gains from the bets are private, and theirs to keep, but all the losses are distributed to the public via government bailouts or money-printing. The first shifts the losses to the taxpayer, and the second shifts the losses to everyone holding the currency being devalued.

The bankers and Wall Street have accumulated even greater wealth thanks to deregulation, allowing the rigged casino to take hold. They will exert even more influence via lobbyists and donations going forward. Too big to fail means the public, the taxpayer is left to genuflect before Wall Street.

The global CB moves are propping the system up temporarily, a short term liquidity fix but the fundamental and structural issues of course are still there. It amounts to a band-aid. There’s still Greece (we forgot about Greece, became a sideshow), Italy, Spain and maybe France (which from I read is a little bit unclear) to contend with. Defaults on the horizon. I don’t know what sort of financial alchemy can be created this time to save the bankers.

One thing to note about the piece. Financial crimes are brazen, they’ve become systemic. Judge Rakoff slapping down the SEC/Citibank settlement was a welcome crumb but a lone crumb nonetheless. We’ll see if the powers that be get the case moved to a different court.

The plundering and pillaging of the national treasury by criminal Wall Street bankers continues, non-enforcement of existing laws against those who committed the largest crime in history is status quo. Market fundamentalism reigns.

Meanwhile young people across the country are getting beaten, bludgeoned, shot with tear gas and pepper sprayed by police. That’s where the enforcement seems to be happening.

Some tragic irony here.

Posted by TheUSofA | Report as abusive

As far as I can understand it, it seems to me the policy that Angela Markel and Nicolas Sarkozy support are against the the methods used described in the article- i.e. the banksters. No, to the creation of money, no to Eurobonds, etc.

I can remember 4 years ago of so when Paul Krugman warned the German austerity would only put them in a worse position but that has not proved to be the case.

Posted by anon9254 | Report as abusive


Posted by TheUSofA | Report as abusive

I am one of the lucky taxpayers who still has a good job. If the government took my house, my car and sold everything I own except one change of clothes and a warm winter coat… and did the same for all of the “middle class” taxpayers in America, they would still not have enough money to pay off our debt.

At some point, creditors might be forced to seek repayment from the people who are capable of paying, but it might take a crisis like the one the Eurozone is experiencing to make it happen.

Posted by breezinthru | Report as abusive

@ breezinthru,

there is no reason we cannot manage the debt we have or even a larger debt, as I have explained in other columns. To get historical perspective please read 6/column-dcjohnston-norquist-idUSN1E76P0 MH20110726

That said, governments should levy as much as they spend over the long run. We ran modest deficits, fully explainable by long-term capital investments in commonwealth goods like roads and harbors, before Reaganism began in 1981.

Posted by DavidCayJ | Report as abusive

A rehash of Nouriel Roubini et al. in a single page. In short, Reaganomics was the conservative response to Johnsonian Great Society Policy, and failed just a miserably.

Posted by SanPa | Report as abusive

The author is correct about the problems of deregulated financial institutions in the West. This criminal creed continues to be spread by Republicans and the Tea Party. Watching this approaching disaster for over a decade, I have been moving assets to other countries, most of whom are communist or former communist nations because there has been a breakdown of law and order in the democracies. In addition, the returns are better because the leaders believe in plans, so investors have some ideas of goals and objectives that allow measurement of progress. As a former Special Forces soldier, it seems bizarre to aid the economic development of countries that I once prepared to infiltrate to sabotage their economies and reduce their ability to support their armed forces. One can only hope that, one day, the democracies will regain the courage to arrest, try, and punish corporate thieves with the same zeal that they use against muggers and armed robbers. Until then, it looks like I will help the communists and former communists to dominate the world because the West cannot be trusted at this time. I will warn the West to change, but I will invest my money where the returns are best, and it is the West’s fault if it fails.

Posted by alanchristopher | Report as abusive

Based on this information, the best solution for the U.S. is a Justice Dept break-up of the mega-banks (ala AT&T) into banking (local) and non-banking institutions (long distance) so that clarity in the social contract between what our government backstops, bank deposits and a stable financial transaction environment and what it “should” not – normal capital market activities and financially engineered speculative bets placed by mega financial institutions. Such a break-up will clear the air, and return the cost of capital for a more focused, less risky banking sector to where it should be. Today the sector is trading more like a gambling casino than a regulated utility which is very unhealthy for bog standard business activity. This leaves major incongruities in the market between very large credit-worthy businesses that can make their own market for credit, and small businesses that cannot – strangling the economy leading to major income inequality. Add a Federal Reserve that thinks it is curing the problem by buying all the U.S. Treasuries off the market that Obama can get Congress to allow him to issue, and you have the formula a financial catastrophe as money dis-intermediates what should be a stable regulated banking sector due to distortions in the markets for bank deposit rates (too low – savers are required to subsidize risky financial instruments they should not have to) and bank equity capital (to high for a normal bank – equity capital is being withdrawn from the sector due to the added risk in the bank capital structure). If our government does not do this soon, it will find itself in the catastrophic position of trying to backstop the entire equity market – not a possibility. The only practical direction will be to carve out the clear banking assets that belong in the regulated utility world that provided great stability from the 1930’s until the 1990’s – and return the riskier capital market activities to where they belong so that the market can get rid of these government induced price distortions. We all we be better off when this happens.

Posted by TeeTime | Report as abusive