The taxpayers’ burden
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 WILL PAY?
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.
CUTS TO LAW ENFORCEMENT
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.