Theme: Externalities

**GALBRAITH AND REGULATION: HE’S GOT IT WRONG AGAIN**

May 6th, 2009

On Angry Bear, there is a posting referring to a statement by Galbraith by the Texas Observer. It’s entitled “James Galbraith remarks“.

Texas Observer carries commentary that is revealing.

Editor’s note: These remarks were delivered to a meeting of the Texas Lyceum in Austin on April 3, at a debate between University of Texas professor James Galbraith, an Observer contributing writer, and former Majority Leader Richard Armey, chief instigator of the recent Astroturf “tea party” protests. Armey had begun his remarks by noting that his rule in life was “never trust anyone from Austin or Boston,” and proceeded to declare his allegiance to the “Austrian School” of economics, a libertarian view that regards public intervention in private markets as socialism.

It is of course a pleasure to be with you today. I was born in Boston, and I am proud of it. And I have lived 24 years in Austin—and I’m proud of that.

Leader Armey spoke to you of his admiration for Austrian economics. I can’t resist telling you that when the Vienna Economics Institute celebrated its centennial, many years ago, they invited, as their keynote speaker, my father [John Kenneth Galbraith]. The leading economists of the Austrian school—including von Hayek and von Haberler—returned for the occasion. And so my father took a moment to reflect on the economic triumphs of the Austrian Republic since the war, which, he said, “would not have been possible without the contribution of these men.” They nodded—briefly—until it dawned on them what he meant. They’d all left the country in the 1930s.

My own economics is American: genus Institutionalist; species: Galbraithian.

This is a panel on the crisis. Mr. Moderator, you ask what is the root cause? My reply is in three parts. (below the fold)

First, an idea. The idea that capitalism, for all its considerable virtues, is inherently self-stabilizing, that government and private business are adversaries rather than partners; the idea that freedom without responsibility is a viable business principle; the idea that regulation, in financial matters especially, can be dispensed with. We tried it, and we see the result.

Second, a person. It would not be right to blame any single person for these events, but if I had to choose one to name it would be a Texan, our own distinguished former Senator Phil Gramm. I’d cite specifically the repeal of the Glass-Steagall Act—the Gramm-Leach-Bliley Act—in 1999, after which it took less than a decade to reproduce all the pathologies that Glass-Steagall had been enacted to deal with in 1933. I’d also cite the Commodity Futures Modernization Act, slipped into an 11,000-page appropriations bill in December 2000 as Congress was adjourning following Bush v. Gore. This measure deregulated energy futures trading, enabling Enron and legitimating credit-default swaps, and creating a massive vector for the transmission of financial risk throughout the global system. When the Washington Post caught up with me at an airport in Parkersburg, West Virginia, a year ago to ask for a comment on Gramm’s role, I said very quickly that he was “the sorcerer’s apprentice of financial instability and disaster.” They put that on the front page. I do have to give Gramm some credit: When the Post called him up and read that to him, he said, “I deny it.”

Third, a policy. This was the abandonment of state responsibility for financial regulation: the regulation of mortgage originations, of underwriting, and of securitization. This abandonment was not subtle: The first head of the Office of Thrift Supervision in the George W. Bush administration came to a press conference on one occasion with a stack of copies of the Federal Register and a chainsaw. A chainsaw. The message was clear. And it led to the explosion of liars’ loans, neutron loans (which destroy people but leave buildings intact), and toxic waste. That these were terms of art in finance tells you what you need to know.

This is another case in which I wish economists were better philosophers and philosophers were better economists.

It was the Austrians who said this quantitative nonsense wouldn’t work. So I don’t understand his arguments against Austrians. Secondly, none of us are against regulation so much as against the idea that regulators possess wisdom. If we simply forced originators to hold 20% of each of their loans (and to separate on the balance sheet public and private investment, and to take losses accordingly), then most of this regulatory problem would go away. Libertarianism is not a vehicle for promoting wild west theft by deception. It’s just that we acknowledge that regulators are an expensive, ignorant, and often political problem because they cannot possess the knowledge required to do the assigned job. Property in itself is regulation. So Austrians are not against regulation. They’re against a system of policing that requires a man to possess knowledge that he cannot have, and against empowering the state.

We just learned a lot about banking and the fact that collateral isn’t collateral any longer. That reliance on collateral is not a very useful means of risk measurement in a credit-money society. We just learned that a lot of actuarial information isn’t really what we thought it was. We just learned a lot about the mathematics of subsets and how they do not scale. We just learned a lot about the “dynamic stochastic equilibrium model,” in that the world is not equilibrial or efficient, but disequilibrial and innovatively equilibrating, as it consumes new opportunities, not as it efficiently produces desired effects. We learned that none of these devices is a substitute for individual human knowledge.

There is little difference between “complex financial instruments” and “herbal remedies.” The consumer, and most of the time the manufacturer, think that these things actually work. There were volumes of literature saying that financial instruments would, and much less volume produced by Austrians saying that they not only wouldn’t, but couldn’t. So, this isn’t an issue of fraudulent behavior. Restitution is not possible for complex financial transactions. There is nothing left to repossess. This isn’t an Austrian problem, it’s a Knightian-Keynesian problem. Deregulation isn’t an Austrian problem. Knowledge is an Austrian problem. Property implies knowledge, and value expressed as numbers cannot represent that knowledge equally to different people, only experience tagged by reference numbers can.

So if you want to say that in the constant political warfare between the socialist-statists and the capitalist-libertarians, each who uses the policy of, and conflict between, the quantitative school (mainstream) and the psychological school (Austrian), and that by virtue of that conflict we created a perfect storm, which allowed deregulation while implementing formulae and financial instruments, then that is true. But it’s true because we did not replace regulation with responsibility by requiring retention of risk when using public-financed credit money. In other words, we violated the principle of property, because property requires knowledge. If you don’t know what it is, then it can’t be property. If it isn’t property, then it’s snake oil. If it’s snake oil, it’s not libertarian, it’s just THEFT AND DECEPTION.

Each of these systems of thought is an interdependent system. You cannot have it both ways. I suppose it is better that we argue over economic productivity and redistribution than that we argue over religion, or of what’s “just,” so perhaps that’s an advancement in human development. But in terms of regulation, it’s simply ridiculous to create a complex web of financial regulation and law to attempt to compensate for the fact that we want to absolve bankers from holding loans that they originate. In other words, the Austrian view is that the state created the problem and makes it worse with regulation.

Property is a form of REGULATION. So Austrians CAN’T say that are against regulation. Regulation isn’t the problem. It is the kind of regulation that we do. We have created a catastrophe by not regulating violations of property. That violation is that property requires individual knowledge, or it’s NOT property, because it CAN’T be property. We only NEED property because we need to break the world up into little, perceptible bits that can be used to exchange with each other. If we could perceive everything, we wouldn’t NEED property. We can’t perceive everything, so we DO need property. And to have property you have to perceive it. If you exchange something with someone else, something that you don’t understand, you’re selling magic. Magic isn’t property, it’s deception. It’s deception even if it’s self-deception. It’s self deception because you cannot pass the test of personal knowledge.

Fundamentally, when all is said and done, and when we solve what we loosely call the problem of induction and produce the next version of capitalism, the Austrians will have been the “most right.” Almost nothing we have done in Macro is of merit, except to prove Austrian insights and to fix Austrian errors (”stickiness”). Even the anarchic research program, which is not something we could ever practically implement, has taught us valuable lessons, and it has taught us how easily replaced are state functions. Just as the Marxian program has taught us valuable lessons. Mostly bad ones. But while we continue to evolve our knowledge of cooperating in larger and larger numbers, we need to keep in mind that there is no end of history. Only the practical policy of the moment. Management of an economy may “thrill the intellectual’s mind,” as Hayek said. Because it gives his fantasy a chance at reality. However it’s a fantasy. It always will be.