David Cay Johnston

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.

By David Cay Johnston
The opinions expressed are his own.

Taxpayers can expect ever more picking of their pockets by businesses with political clout thanks to the Nov. 21 decision by Judge Theodore Jones and four colleagues on the New York Court of Appeals.

At issue is $1.4 billion in state gifts whose primary beneficiary is a microchip maker, GlobalFoundries, a company controlled by Abu Dhabi’s hereditary ruler, Sheikh Khalifa bin Zayed Al Nahyan, one of the wealthiest people ever. The gifts, labeled economic development grants and made through a state-sponsored corporation, work out to about a million dollar subsidy per job at the plant near Albany.

The New York Court of Appeals said the 50 taxpayers who sued over the deal and over gifts to apple and wine trade associations have no standing to challenge the gift because it is proper.

While this case concerns only New York, it illustrates how corporate socialism has become our de facto economic policy and how the ideal of competitive markets and self-reliance are fading in significance.

State and local gifts to corporations now run at least $70 billion per year nationwide, according to an estimate by Professor Kenneth Thomas of the University of Missouri-St. Louis.

I think Thomas’s estimate is conservative, in good part because many states and local governments make spotty disclosures or low-ball figures.

DISTORTED MARKETS

Not only do these gifts distort markets, they also destroy many entrepreneurial businesses and help a relatively few giant companies with influence earn profits using taxpayer capital.

GlobalFoundries says that upstate New York is a costly place to do business and that, but for the subsidy to offset these higher costs, it would have built the plant elsewhere.

The New York ruling makes future challenges of corporate gifts virtually impossible. The court decided that before having any opportunity to compel testimony or disclosure of documents, plaintiffs must prove a gift is unconstitutional using the standard of proof in criminal cases: beyond reasonable doubt.

Any gift to the sheikh’s company seems clearly at odds with Article VII, Section 8 of the state constitution, which states that “the money of the state shall not be given or loaned to or in aid of any private corporation or association, or private undertaking; nor shall the credit of the state be given or loaned to or in aid of any individual, or public or private corporation or association, or private undertaking.”

New York voters prohibited gifts to companies in the 1846 state constitution. The ban came after failed railroad and canal companies stuck taxpayers with their obligations in the 1830s, which accounted for about 60 percent of the state’s debts back then.

And it’s not as if voters said no just once. They affirmed the ban, and strengthened it, in 1874 and again in 1938. Voters were savvy enough to see through a slyly worded proposal to undo the ban on gifts, voting it down in 1967.

So how did Judge Jones, who wrote the decision, along with Chief Judge Jonathan Lippman and Judges Carmen Beauchamp Ciparick, Victoria A. Graffeo and Susan Phillips get around the voters saying no, no, no and no?

They ruled that while the state “may not lend its credit to a public corporation,” nothing “prohibits the State from adopting appropriations directed to” intermediaries who can then give the money, or credit, to private corporations.

A MOCKERY

That’s absurd. To suggest that what the state cannot do directly it can do by passing the money through a separate corporation it created is to make a mockery of the state constitution. Applying the same standard in criminal law would mean that crime family bosses and drug kingpins could escape prosecution by having subordinates do the dirty work.

In a dissent, Judge Eugene Pigott meticulously deconstructed the errors of logic and willful blindness of the majority. He quoted the great jurist Benjamin Cardozo in a case declaring that gifts to World War One veterans violated the gift clause.

Judge Cardozo wanted to allow the gifts to soldiers, writing that the gift ban was not intended to prevent recognizing honorable service to country, but “to put an end to the use of credit of the state in fostering the growth of private enterprise and business.”

Judge Pigott said he was unimpressed by the majority argument that corporate gifts have a long history. “Unconstitutional acts do not become constitutional by virtue of repetition, custom or passage of time,” he wrote. Amen.

Judge Robert S. Smith heartily endorsed Pigott’s dissent and wrote his own.

The New York Legislature, Judge Smith wrote, “is free to disregard both received economic teachings and common sense … But when our Legislature commits the precise folly that a provision of our Constitution was written to prevent, and this Court responds by judicially repealing the constitutional provision, I think I am entitled to be annoyed.”

Taxpayers deserve to be more than annoyed at judges who concoct arguments to justify taking from all to give to the select few, in this case to the fabulously wealthy ruler of Abu Dhabi, who hardly needs a subsidy. All voters can do is hope that one day judges who are not in the thrall of corporate interests will put the public interest, and the plain language of the state constitution, first.

Photo: A handout picture from Emirates News Agency WAM shows Emirati President Sheikh Khalifa bin Zayed bin Sultan al-Nahyan (R) greeting Omani sultan Qaboos bin Said in Abu Dhabi July 11, 2011. REUTERS/WAM/Handout