WALL STREET; MEET YOUR NEW BOSS

There's No Stimulus Free Lunch

It's hard to spend wise and spend fast.

GARY S. BECKER KEVIN M. MURPHY

How much will the stimulus package moving in Congress really stimulate the economy?

The evaluations to date have been incomplete, so we looked at the likely stimulative effect from the spending parts of the House and Senate bills -- over $500 billion -- and assessed the quantitative effects of four basic factors.

Corbis

1) How much increase in Gross Domestic Product (GDP) can be expected from the stimulus package?

In a full-employment situation, increased government spending would largely replace private spending, so the net stimulus to GDP would likely be quite small. In the present environment, however, with growing unemployment of both labor and capital, the net stimulus would be larger since the additional government spending would put some unemployed resources to work.

For example, if the government spent money to build new homes with unemployed labor, the stimulus to GDP might be close to, even larger than, the amount spent. However, given the present housing glut, that hardly seems to be a wise policy, although it is a small part of both the House and Senate stimulus packages.

In fact, much of the proposed spending would be in sectors and on programs where the government would mainly have to draw resources away from other uses. This type of spending includes adding broadband to rural areas, spending more on health coverage, encouraging scientific innovations, developing renewable energy, as well as many other things.

As President Barack Obama recently said, "This plan is more than a prescription for short-term spending -- it's a strategy for America's long-term growth and opportunity in areas such as renewable energy, health care and education." Such spending may encourage long-term growth, but it will have little short-term effect on GDP.

So our conclusion is that the net stimulus to short-term GDP will not be zero, and will be positive, but the stimulus is likely to be modest in magnitude. Some economists have assumed that every $1 billion spent by the government through the stimulus package would raise short-term GDP by $1.5 billion. Or, in economics jargon, that the multiplier is 1.5.

That seems too optimistic given the nature of the spending programs being proposed. We believe a multiplier well below one seems much more likely.

2) The increased government spending in the stimulus package is supposed to be only temporary, until the economy returns to a full employment level, but probably won't be.

The evidence of past expansions of government programs is just the opposite. Once created they tend to survive and grow over time, even when the increases initially were said to be temporary. The underlying reason for this is that interest groups develop around new and expanded programs, and they lobby to keep and expand those programs.

This implies that the spending programs in the stimulus package will continue to some extent after the economy has returned to full employment. The multiplier at that time will surely be much closer to zero. Looking several years ahead, then, the average stimulus from the expansion in government spending will be smaller, perhaps much smaller, than the short-term stimulus.

3) The effects on consumers and businesses of the stimulus package depend not only on the stimulus to short-term GDP, but also on how valuable the spending is.

Whatever the merits of other government spending, the spending in this package is likely to have less value. A very large amount of money will be spent quickly over a two-year period: $500 billion amounts to about one-quarter of the total federal government annual spending of $2 trillion. It is extremely difficult for any group, private as well as public, to spend such a large sum wisely in a short period of time.

In addition, although politics play an important part in determining all government spending, political considerations are especially important in a spending package adopted quickly while the economy is reeling, and just after a popular president took office. Many Democrats saw the stimulus bill as a golden opportunity to enact spending items they've long desired. For this reason, various components of the package are unlikely to pass any reasonably stringent cost-benefit test.

4) There are no free lunches in spending, public or private.

The increased federal debt caused by this stimulus package has to be paid for eventually by higher taxes on households and businesses. Higher income and business taxes generally discourage effort and investments, and result in a larger social burden than the actual level of the tax revenue needed to finance the greater debt. The burden from higher taxes down the road has to be deducted both from any short-term stimulus provided by the spending program, and from its long-run effects on the economy.

We believe that it is incumbent on both supporters and opponents of the bill to thoughtfully evaluate each of these four factors. We recognize that how individuals will come out in their own evaluation of these factors will determine their attitude toward the stimulus package, and that there is considerable ground for reasonable differences of opinion.

Our own view is that the short-term stimulus from the legislation before Congress will be smaller per dollar spent than is expected by many others because the package tries to combine short-term stimulus with long-term benefits to the economy. Unfortunately, short-term and long-term gains are in considerable conflict with each other. Moreover, it is very hard to spend wisely large sums in short periods of time. Nor can one ever forget that spending is not free, and ultimately it has to be financed by higher taxes.

Mr. Becker, the 1992 Nobel economics laureate, is professor of economics at the University of Chicago and senior fellow at the Hoover Institution. Mr. Murphy, a MacArthur Fellow, is an economics professor at the University of Chicago and a senior fellow at the Hoover Institution.

Pelosi's Indefensible Bill

For Barack Obama, a cautionary tale of audacity.

By WILLIAM MCGURN

Historians tell us it was Roman custom to place a slave in the chariot behind a conquering hero, there to whisper warnings about the fleeting nature of fame amid the accolades of adoring crowds.

Martin Kozlowski

Barack Obama is no stranger to the cheers of roaring crowds. If his prime-time press conference last night is any clue, moreover, he intends to use this personal popularity to help Congress get a stimulus bill to his desk quickly. As he does, those who wish his presidency success might do well to whisper in his ear two words of tempering wisdom: "Nancy Pelosi."

In the public eye as well as on Capitol Hill, the California Democrat has become the mother of all stimulus packages. Whatever issues Mrs. Pelosi may claim with the Senate version, her leadership has defined the direction. Her intransigence has set the tone. And her penchant for excess helps explain why out of 535 members of Congress, only three Republicans seem willing to go anywhere near the thing.

Therein lies a cautionary tale.

In the afterglow of President Obama's inauguration, it's easy to forget that Mrs. Pelosi's similarly historic elevation to the speaker's chair just two years ago had its own elements of a coronation -- and its own claims of change we were to believe in.

Like President Obama, who characterized his ascent to the White House as a mark of "how far we have traveled," Speaker Pelosi spoke of her swearing in as a "moment for which we have waited more than 200 years."

Like President Obama, whose supporters made ubiquitous a red, white and blue image of the candidate over the word "hope," Speaker Pelosi's supporters brandished their own icon at her swearing-in: commemorative buttons depicting her as Rosie the Riveter flexing her muscle.

And like President Obama, Speaker Pelosi heralded her election as "a call to change." In her acceptance speech, she put it this way: "We have made history," she said. "Now let us make progress for our new America."

That was January 2007. Before the year was out, her approval ratings would be lower than George W. Bush's.

Under her leadership, Congress failed to pass a single appropriations bill until early November. Congress also failed to override the president's veto on what Democrats thought would be an easy win for an expansion of the State Children's Health Insurance Program. Most significant of all, Congress failed to force Mr. Bush to begin what Democrats had said was their real goal: a U.S. withdrawal from Iraq.

The way Mrs. Pelosi handled Iraq has some interesting parallels to the way she is now handling the stimulus. In the early months of her speakership, the Democratic Congress faced its first test on Iraq in the form of a war funding bill. Mrs. Pelosi's response? To lard it up with billions in unrelated domestic spending -- including a now infamous provision that would have spent $74 million for peanut storage.

In many ways, Mrs. Pelosi's decisions would make it easier for Mr. Bush to get his war funding through her Congress. While the president argued for supporting our troops, Democrats were forced to defend pork. And though Mr. Bush was ultimately forced to accept more domestic spending than he would have preferred, on the central issue -- funding for the war -- he got what he wanted without agreeing to a timetable for withdrawal.

Just as she did with war funding, Mrs. Pelosi is once again putting her fellow Democrats -- Mr. Obama included -- in the position of defending the indefensible. And she let it all ride on a game of chicken. Her bet has been that a Republican minority would sooner or later cry "uncle" on a laundry list of pet Democratic spending projects rather than risk being painted as holding up vital economic legislation.

But a funny thing happened: House Republicans called her bluff. The result has been more attention to the content of the legislation passing through Congress. And as the focus on content has increased, the American people have grown more skeptical.

In public, Mr. Obama may tell us the problem is the lack of Republican support. But if he is as comfortable with the stimulus as he says, if the bills under consideration are really the tonic our economy needs, if by not passing a stimulus immediately we truly risk catastrophe, and if the American people are going to call the Republicans to account for not going along, why all the fuss? Why not just have it passed on your own, and take full credit.

Unless, of course, even Democrats are beginning to hear whispers of "Nancy Pelosi" ringing in their ears.

There Is Room for Rate Cuts

The euro will not only survive the crisis, but will also become more attractive for new countries in the future.

PEDRO SOLBES

There is little doubt that the world faces an unprecedented financial crisis and that advanced economies are suffering their worst recession since World War II. Developing economies have also been hit and, although they face this crisis in a better situation than in the past, they too are experiencing a deep downturn. As a result, global trade is suffering a sharp slowdown. Despite rapid policy responses, financial markets remain distressed, generating a negative feedback loop between recession and financial strains.

Barbara Kelley

Certainly, the initiatives adopted so far go in the right direction and will bear fruit gradually in the coming months. Therefore, in spite of the highly uncertain outlook, we can expect global growth to bottom out in late 2009 and a gradual recovery in 2010. The most important thing now is to implement quickly all the envisaged stimulus packages and to avoid succumbing to protectionist pressures. On the contrary, what we need is to step up the degree of active coordination as the economic crisis deepens.

Since the outbreak of the financial crisis, and in particular after the bankruptcy of Lehman Brothers last September, policy makers have taken swift and coordinated actions that have successfully averted a financial meltdown. However, these initiatives have not been sufficient to restore confidence and resume the normal functioning of the markets. The interbank markets have certainly showed some positive developments since the announcement of national rescue measures. On the other hand, spreads in credit markets have narrowed only moderately despite government guarantees, and bank lending to the private sector has weakened markedly, pulling down the real economy.

The persistent financial turmoil is contributing to the collapse of output not only through tighter credit, but even more importantly through a decline in wealth, a deteriorating confidence and a high level of uncertainty. All these factors act together, putting downward pressure on consumption and investment. Against this backdrop, decisive action is required to restore financial-sector functionality. In many cases there is a need to strengthen solvency. To avoid a disorderly deleveraging process, distressed assets have to be dealt with promptly and banks recapitalized when necessary.

Now it is time to cleanse balance sheets, but we should be very careful not to raise capital requirements beyond reasonable levels. In this respect, recapitalization schemes should avoid introducing new financial distortions and limit harmful subsidy races in order to ensure a level playing field and prevent unnecessary financial protectionism. Therefore, we must take measures to respond to the current financial turmoil and at the same time draw lessons to prevent future financial crises.

Under these circumstances, there is a need for monetary and fiscal policies to sustain faltering demand. Central banks are taking strong actions to improve market liquidity and have brought down policy interest rates aggressively, although in the euro zone there is still room for additional cuts. Despite some disparity in economic performance across countries, the European Economic and Monetary Union is helping all member states to weather the financial turmoil. The euro will not only survive the crisis, but will also become more attractive for new countries in the future.

As the monetary transmission channel may be somewhat less effective in the current situation, fiscal policy has to play a particularly important role. Last December, the European Council agreed on a European Economic Recovery Plan to combat the current severe economic downturn, based on a combined fiscal effort of 1.5% of GDP. In 2009 and 2010 the total amount of support provided by fiscal policies is estimated above 3% of GDP. Now it is time to focus on the rapid implementation of the announced fiscal stimuli, not only in Europe but everywhere else, taking account of country-specific circumstances as appropriate. In those cases where there is still some spare fiscal capacity, additional expansive measures should be adopted urgently.

In view of the rapid increase in budget deficits and public debt, we have to commit to a credible adjustment strategy to reverse the budgetary expansion once the crisis is over. By these means, we want to ensure long-term sustainability of public finances and prevent adverse market reactions.

In times of uncertainty it is more important than ever to keep a long-term perspective. Definitely, structural reforms have also an essential role to play, as they can help restore confidence, strengthen resilience and facilitate a swift and sustainable recovery. Hence, it is important to ensure that short-term measures to address the downturn are consistent with long-term policy objectives. This crisis provides a good opportunity to increase momentum for important reforms supporting adaptability, innovation and competitiveness.

In 2007, after 13 years of solid growth, Spain's economy began to slow down. The global financial crisis has accelerated the downturn considerably. The housing sector, which had expanded vigorously for a long period, initiated a deep correction taking its toll on economic activity and employment. The government has responded promptly to mitigate the impact of the financial turmoil.

First, we have adopted a substantial fiscal expansion package aimed at sustaining aggregate demand. In 2009, discretionary fiscal actions will provide a an economic stimulus of more than 2% of GDP. This bold fiscal policy has been possible because Spain entered the crisis with a sound fiscal position. In 2007, the Spanish government obtained a budget surplus of more than 2% of GDP while public debt was 30 percentage points below the euro zone's average.

Second, we have implemented market-based policies in the financial sector aimed at restoring confidence and providing funding. Fortunately, the Spanish financial system is showing remarkable resilience since Spanish banks have remained focused on retail banking and under a strict supervision. Nevertheless, we are closely monitoring the situation and remain ready to take further steps if necessary.

Now it is time to give a boost to structural reforms and, in particular, to reducing administrative burdens, further liberalizing key product markets and improving the functioning of the labor market. These structural measures, together with effective fiscal stimuli, low interest rates and increased financial stability, will underpin the recovery.

All in all, this is a very demanding time for both public authorities and private-sector managers, a time for prompt action and leadership. We need to restore confidence and curb uncertainty, so as to get the global economy firmly back on its feet as soon as possible.

Judge Napolitano on Glenn Beck 02/09/2009

Tom Woods on Glenn Beck "Meltdown" 02/09/2009

Official figures obscure China's decline

Joe McDonald ASSOCIATED PRESS

BEIJING | Plunging exports. Factory closures. More than 20 million people thrown out of work. Official data showing that China's economy is cooling but still growing strongly obscure what economists say is a sharp recent decline that has inflicted obvious pain.

What is happening matters far beyond China. Whether the third-largest economy is stalling or still growing could affect how quickly the world recovers. A stagnant China would mean less demand for industrial materials and consumer goods from the United States and others.

The difference lies in the way growth is measured. Beijing uses a method that compares growth in one quarter with a full year earlier and says its economy expanded by a healthy 6.8 percent in the final quarter of 2008.

But experts say that compared with the previous three months - the system used by most other major countries - China's growth fell to as low as 1 percent or possibly zero.

"The recent weakness is much worse than the long-term trend," said JP Morgan economist Frank F.X. Gong. Merrill Lynch economist Ting Lu said fourth-quarter growth from the previous three months was "close to zero."

The lower quarter-on-quarter growth figure would be in line with other indicators that show exports and manufacturing falling and weakness in investment and consumer spending.

The pain is evident on factory floors and in empty restaurants and shops.

Sales at the Laiwu Sheng Yuan Building Materials Co. have plunged 50 percent from a year earlier, said General Manager Wang Jian. He said construction companies are in such bad shape he is reluctant to fill orders.

"I'm afraid they won't be able to pay," said Mr. Wang, whose company in the eastern city of Laiwu has 100 employees. "Builders already owe me more than $29 million, and I don't know when I'm going to get it back."

ASSOCIATED PRESS Two job seekers fill out application forms for interviews at a job fair in Beijing on Friday. China's disconcerting secret is that its economic slump is much deeper than official data show.

Other Asian economies such as Japan and South Korea are shrinking, which would make Chinese growth of even 1 percent encouraging. Beijing says there are signs its $586 billion stimulus applied in November is taking effect.

A key indicator of manufacturing improved in January, suggesting the slump might be reaching its bottom. But the purchasing managers index of the China Federation of Logistics and Purchasing said manufacturing still contracted.

"Despite the sunny headline figure, we believe it signals not a recovery, but rather continued weakness," Standard Chartered economist Stephen Green said in a report. "Less bad news is not the same as good news."

Countries such as the United States and Japan report gross domestic product growth by comparing each quarter with the previous quarter. That requires more number-crunching to adjust for seasonal differences but quickly reveals changes in performance.

The gap in measurement is well known to private-sector economists, who try to estimate China's quarter-on-quarter growth based on skimpy government data.

Fourth-quarter growth compared with the previous three months fell to 1 percent at an annual pace, down from 4 percent the previous quarter, according to Mr. Green.

"We sharply decelerated in November and December," he said. "There are no clear signals we have accelerated."

JP Morgan gave an estimate of 1.5 percent quarter-on-quarter annualized growth. But its figures also highlight a sharp decline: That rate is just one-tenth of the 15 percent quarter-on-quarter growth the bank says China achieved in early 2007.

Exporters and China's trade-driven southeast coast have been hit hardest, but weakness has spread to other regions and industries such as real estate and auto sales.

The Action Americans Need

An Editorial by Barack Obama Thursday, February 5, 2009; Washington Post
(Interspersed with comments by various authors.)

"By now, it's clear to everyone that we have inherited an economic crisis as deep and dire as any since the days of the Great Depression. Millions of jobs that Americans relied on just a year ago are gone; millions more of the nest eggs families worked so hard to build have vanished. People everywhere are worried about what tomorrow will bring."

Rather than spending money we don't have, I wish Obama would use his political capital to change the parts of our political system that are dysfunctional - our entitlement programs that are demographically bankrupt, our broken budget system, our Byzantine tax system, our financial system that is in disarray. These changes would be more likely to create the confidence and trust in the future that our economy needs to get healthy again rather than borrowing and spending. Borrowing and spending is how we got into this mess. Let's look in a different direction.

--Russell Roberts, professor of economics at George Mason University, “Stimulus just digs debt hole deeper.”

"What Americans expect from Washington is action that matches the urgency they feel in their daily lives -- action that's swift, bold and wise enough for us to climb out of this crisis"

The saying “First, do no harm” is the cardinal rule of medicine. It applies equally to economic policy. At the very time that the Senate is debating whether to spend $800 billion or $900 billion to stimulate the economy, the government is considering other legislative and regulatory initiatives that would impede economic recovery.
--Diana Furchtgott-Roth, First Do No Harm RealClearMarkets

"Because each day we wait to begin the work of turning our economy around, more people lose their jobs, their savings and their homes. And if nothing is done, this recession might linger for years. Our economy will lose 5 million more jobs. Unemployment will approach double digits. Our nation will sink deeper into a crisis that, at some point, we may not be able to reverse."

American Institute for Economic Research Research Reports Vol. LXXVI, No 2 Feb. 2, 2009
"In absolute terms, 2.6 millions is indeed the biggest annual job loss since 1945...However, it's a great exaggeration to say this represents the worst annual job loss since World War II...A 2.6 million job loss represents a much smaller percentage of the work force now than it did back then...The risk is that such exaggerations will further erode the confidence of consumers, businesses, and investors, and be used to justify extraordinary policy responses to not-so-extraordinary cyclical phenomena."

"That's why I feel such a sense of urgency about the recovery plan before Congress. With it, we will create or save more than 3 million jobs over the next two years, provide immediate tax relief to 95 percent of American workers, ignite spending by businesses and consumers alike, and take steps to strengthen our country for years to come."

Borrowing to “put money in people’s pockets,” say, by tax rebates, is exactly as pointless (or inflationary) as borrowing and spending. but lowering the distortions caused by high tax rates can do a lot of good. However, to really do any good, tax rates have to be low and predictable for a long time…Even if we borrow to lower tax rates, we have to raise tax rates in the future to pay back the debt, so any borrowing-financed tax reduction can’t be permanent and thus have the desired incentive effects. the only real fiscal “stimulus” is to lower tax rates, broadening the base, while at the same time attacking the structural deficits that everyone knows otherwise mean higher tax rates in the future.
--John Cochrane, “Fiscal Stimulus, Fiscal Inflation, or Fiscal Fallacies?”

"This plan is more than a prescription for short-term spending -- it's a strategy for America's long-term growth and opportunity in areas such as renewable energy, health care and education. And it's a strategy that will be implemented with unprecedented transparency and accountability, so Americans know where their tax dollars are going and how they are being spent."

[A]t various times in American history, moments like this one have been used for big programs, from integrating the armed forced to creating Social Security and, later, Medicare. So it is little wonder that everyone with a big, stalled, transformative project--green energy programs, broadband networks that reach into rural America, health insurance for the newly unemployed or uninsured—is citing the precedent of Franklin D. Roosevelt, and declaring that a New deal is over due.
--David Sanger, “A Stimulus Plan with Dual Goals: Reform and Recovery” NYT 2-1-09

"In recent days, there have been misguided criticisms of this plan that echo the failed theories that helped lead us into this crisis -- the notion that tax cuts alone will solve all our problems; that we can meet our enormous tests with half-steps and piecemeal measures; that we can ignore fundamental challenges such as energy independence and the high cost of health care and still expect our economy and our country to thrive."

These ideas changed because Keynesian economics was a failure in practice, not just in theory. Keynes left Britain 30 years of miserable growth. Richard Nixon said “we’re all Keynesians now” just as Keynesian policy led to the inflation and economic dislocation of the 1970s…Keynes disdained investment, where we all now realize that saving and investment are vital to long run growth. Fiscal stimulus advocates are hanging on to ..ideas that everyone including they abandoned, and from hard experience, If we forget all that, we could repeat the economics of postwar Britain, of spend-and-inflate Latin America, and of bureaucratic India
--John Cochrane, “Fiscal Stimulus, Fiscal Inflation, or Fiscal Fallacies?"

"I reject these theories, and so did the American people when they went to the polls in November and voted resoundingly for change. They know that we have tried it those ways for too long. And because we have, our health-care costs still rise faster than inflation. Our dependence on foreign oil still threatens our economy and our security. Our children still study in schools that put them at a disadvantage. We've seen the tragic consequences when our bridges crumble and our levees fail."

How can anyone claim that we have tried laissez-faire and it has failed when, as pointed out by Dr. George Resiman:
1) Government spending in the United States currently equals more than forty percent of national income...
2) There are presently fifteen federal cabinet departments, nine of which exist for the very purpose of respectively interfering with...the economic freedom of the individual...
3) The economic interference of today’s cabinet departments is reinforced and amplified by more than one hundred federal agencies and commissions, the most well-known of which include, besides the IRS, the FRB and FDIC, the FBI and CIA, the EPA, FDA, SEC, CFTC, NLRB, FTC, FCC, FERC, FEMA, FAA, CAA, INS, OHSA,CPSC, NHTSA, EEOC, BATF, DEA, NIH, and NASA...
4) To complete this catalog of government interference and its trampling of any vestige of laissez-faire, as of the end of 2007, the last full year for which data are available, the Federal Register contained fully seventy-three thousand pages of detailed government regulations...
5) And, of course, to all of this must be added the further massive apparatus of laws, departments, agencies, and regulations at the state and local level...(emphases are mine)

"Every day, our economy gets sicker -- and the time for a remedy that puts Americans back to work, jump-starts our economy and invests in lasting growth is now."

[A]ny jobs created by government make-work programs will be slow to arrive, quick to disappear again...minimally stimulative to the broader economy as they largely substitute government-based jobs for true private-sector jobs.
--Jim DeMint, Senator, South Carolina

"Now is the time to protect health insurance ...and to computerize the health-care records of every American...Now is the time to save billions by making 2 million homes and 75 percent of federal buildings more energy-efficient, and to double our capacity to generate alternative sources of energy within three years. Now is the time to...upgrad[e] 10,000 schools with state-of-the-art classrooms, libraries and labs...and [bring] the dream of a college education within reach for millions of Americans. And now is the time to create the jobs that remake America for the 21st century by rebuilding aging roads, bridges and levees; designing a smart electrical grid; and connecting every corner of the country to the information superhighway."

The only way [the government] can pay these individuals is by taxing others who are still generating real wealth. By doing this, the government weakens the wealth-generating process and undermines prospects for economic recovery...The only way fiscal stimulus could "work" is if the flow of real savings (i.e. real funding) is large enough to support (i.e. fund) government activities while still permitting a positive rate of growth in the activities of the private sector...If, however, the flow of real savings is not large enough, then, regardless of any increase in government outlays, overall real economic activity cannot be revived...thereby retarding, not promoting, overall real economic growth.
--Frank Shostak, "Can Fiscal Stimulus Revive the U.S. Economy?"

"These are the actions Americans expect us to take without delay. They're patient enough to know that our economic recovery will be measured in years, not months. But they have no patience for the same old partisan gridlock that stands in the way of action while our economy continues to slide.

So we have a choice to make. We can once again let Washington's bad habits stand in the way of progress. Or we can pull together and say that in America, our destiny isn't written for us but by us. We can place good ideas ahead of old ideological battles, and a sense of purpose above the same narrow partisanship. We can act boldly to turn crisis into opportunity and, together, write the next great chapter in our history and meet the test of our time."

So if not a stimulus, then what?

"The first step is to stop chaotic interventions. Who would buy bank stock, lend long term, or buy securitized debt, knowing that the government might rewrite the rules at any point?" --John Cochrane, “Fiscal Stimulus, Fiscal Inflation, or Fiscal Fallacies?"

"Capitalism is in the end reliant on the efficient deployment of capital, and when the blunt hand of government distorts this process, the certain result is less capital for all manner of new business entrants... [W]ithout access to capital, the entrepreneur 'cannot become an entrepreneur'... In short, the answer to these difficult times isn’t more government, but instead a humble government that simply allows producers to produce"
--John Tamny, "Government Solutions are Slowing the Economy" 1-15-09, RealClearMarkets

"Rather than spending money we don't have, I wish Obama would use his political capital to change the parts of our political system that are dysfunctional--our entitlement programs that are demographically bankrupt, our broken budge system, our Byzantine tax system, our financial system that is in disarray. these changes would be more likely to create the confidence and trust that our economy needs to get healthy again rather than borrowing and spending. Borrowing and spending is how we got into this mess. Let's look in a different direction.
--Russell Roberts, "Stimulus just digs debt hole deeper" 02-02-09, Boston Globe

The ultimate solution, of course, is economic freedom: free trade and private property. Successful ventures would retain their profits as the just reward for the efficient use of resources in satisfying real market demand. Inefficient and unsuccessful businessmen would be allowed to fail, and to try again. Free men, protected by the government from fraud and the initiation of force. Free to work, save and spend according to their individual judgment and to the best of their abilities. Free to trade to mutual advantage through voluntary exchange. In other words, ...simply Capitalism.

New York Times Columnist Maureen Dowd Wants Soviet-Style Show Trials with Capitalist Defendants in Shackles

GEORGE REISMAN

New York Times columnist Maureen Dowd has written a column (January 28, 2009) full of withering hatred and contempt for many of today’s most prominent businessmen, first and foremost the heads of the Wall Street Banks. She singles out Citigroup and Merrill Lynch in particular, denouncing the first for going ahead with taking delivery of a $50 million luxury jet at the very time the firm was losing billions, and the last CEO of the second, John Thain, for spending $1 million to redecorate his office, also in the midst of his firm’s suffering major losses.

Her column leaves the reader with a view of these people and, by implication, of practically the whole economic class to which they belong, i.e., virtually all businessmen and capitalists, as having a mentality that combines the worst features of Marie Antoinette and Nero. The former, of course, was Queen of France until 1793, when she was beheaded. She is famous for allegedly having said in response to being informed of the peasantry’s lack of bread, “Let them eat cake.” And Nero was the Roman emperor who is known for having fiddled while Rome burned, and who died in 68 AD, committing suicide when he learned that the Roman Senate had ordered that he be flogged to death.

Having led her readers to such an assessment of these people, she concludes her column with the declaration, “Bring on the shackles. Let the show trials begin.” If they do begin, Dowd will be there, perhaps with knitting needles, in the role of a modern-day Madame Defarge, the Dickens character who knitted while watching aristocrats being guillotined during the French Revolution.

The day after Dowd’s column appeared, a news story in The Times reported that, “Despite crippling losses, multibillion-dollar bailouts and the passing of some of the most prominent names in the business, employees at financial companies in New York, the now-diminished world capital of capital, collected an estimated $18.4 billion in bonuses for the year. That was the sixth-largest haul on record, according to a report released Wednesday by the New York State comptroller.”

The day after that, President Obama called the bonuses “shameful.”

The Fate of Capitalism

It is very easy to interpret the kind of facts that have been described, as an indictment of the capitalist system, which is exactly how they are being interpreted. Millions of people have lost their jobs; millions more fear that they will lose theirs. These millions cannot avoid the further fear that they and their families will be utterly impoverished. And they are being led to blame their losses on capitalism, in large part by being led to blame it on the persons of individual businessmen or capitalists whom they perceive as hateful.

What is present and being inflamed is the psychology of an angry mob. Its sympathies are with innocent victims who have suffered a great wrong. It’s sure it knows who is responsible and how. The next step will be for someone to yell, “Get a rope!”

Already, businessmen and capitalists are starting to cower in fear. Corporations are racing to get rid of their private jets. Next it will be their private dining rooms and limousines. Private profit and personal luxury at any level are in danger before the onslaught of a collectivist mentality that holds that if many are suffering, all must suffer, and, further, that those who do not suffer are responsible for the suffering of those who do. Anyone whose head is above the crowd will risk being a target.

This is the time for everyone to recall whatever instances in his life that he remembers when angry mobs turned out to be wrong. Perhaps it’s only a scene from a movie or book, in which someone is able to present a few facts that the mob doesn’t know and that begin to place things in a different, calmer light. Let me be that someone now and begin with one very important and fundamental relevant fact.

Today’s Economic System Is A “Mixed Economy,” Not Laissez-Faire Capitalism

And that is that even if all of the facts as presented were absolutely true, it would not imply any reason whatever to condemn capitalism. Capitalism is a system in which absurd, self-destructive behavior severely punishes whoever is guilty of it. Such people suffer losses, go bankrupt, and lose their ability to have significant further economic influence. Their example then serves as a lesson to others to avoid such behavior.

However, we are very far from having capitalism today, certainly not capitalism in its logically consistent form of laissez-faire capitalism. What we have today is a “mixed economy,” that is, a severely hampered, distorted form of capitalism. In such a system, such behavior can continue, thanks to government subsidies, grants of monopoly privilege and suppression of competition, and now by means of government “bailouts.”

A mixed economy is an economy which remains capitalistic in its basic structure, but in which the government extensively intervenes with the initiation of physical force to compel actions that are against the interest of individuals and/or to prohibit actions that are in the interest of individuals. For example, today it compels people to pay an income tax, which is against their interest but which they pay in order to stay out of jail. It also prohibits them from engaging in various business mergers or paying wages below a certain amount, things which it would be to their interest to do but now do not, because they wish to avoid being fined or imprisoned. (In my recent article “The Myth that Laissez Faire Is Responsible for Our Financial Crisis,” I present an extensive description of the extent of government intervention.)

A mixed economy lacks the fundamental moral-political principles that are needed to determine what is proper or improper for a government to do. Its only principle, if one can call it that, is that the government can do anything that enough people believe will accomplish what they think is “good,” according to an undefined standard. Our mixed economy rests on the effective discarding of the United States Constitution, which placed severe limits on government power and thus stood as a bulwark in defense of an economic system that was almost one of laissez-faire. The Constitutional protections were discarded by a process of pretending that the Constitution could somehow “grow” or “evolve,” which actually meant nothing other than choosing to ignore it.

In a mixed economy, every significant-sized business must fear what the government can do to it. It needs protection, in the form of political connections. It secures these through appointing former government officials to its board of directors, paying such officials lavish consulting fees, and giving lavish campaign contributions to candidates for public office. In these ways it buys the protection it needs.

But soon businesses learn that their protectors can also be used to gain lucrative government contracts, government subsidies, and monopolistic privileges ranging from tariffs and licensing laws to antitrust suits against competitors. Thus, it is not long before the upper echelons of large firms become populated not only with men who cower before the government but also with those who seek to manipulate the government to their advantage, which is where we are today.

Certainly not all big businessmen are this way, and probably only a few of those that are, are so through and through. For the most part, they still have real jobs to do in running their companies, and to the extent they simply do those jobs, they are productive. But probably most big businessmen are morally compromised if only because they must live in fear of the government and are helpless to do anything about it.

Responsibility for the Financial Crisis

There is a sense in which an important sub-group of businessmen does have genuine responsibility for the present economic crisis and for all previous crises of financial contraction and deflation. This is the sub-group of commercial bankers.

Ironically, the way in which they have been responsible is by means of doing something that almost everyone very much wants them to do, above all, the government, and even when the crisis comes, still wants them to do or to get back to doing as soon as possible. This something is the practice of credit expansion. Credit expansion is the lending out of new and additional money that is created out of thin air, with the encouragement and support of the government. Governments value and encourage credit expansion both in the mistaken belief that it is a source of prosperity and in the knowledge that it is a ready source of money to finance government spending.

Credit expansion is what creates a delusion of prosperity while it lasts and economic depression when it ends. It is all that needs to be stopped to end the boom-bust cycle. (In this brief article, I must ask the reader who wants understand the process, and how to stop it, to be content merely with references to further reading, namely, Chapters XX and XXXI of Ludwig von Mises’s Human Action and Chapters 12 and 19 of my own Capitalism: A Treatise on Economics. Concerning the role of credit expansion in our present crisis in particular, please see my articles “The Myth that Laissez Faire Is Responsible for Our Financial Crisis,” “Our Financial House of Cards and How to Start Replacing It With Solid Gold,” and “The Housing Bubble and the Credit Crunch.”)

I want now to deal with the subjects of bonuses and corporate jets.

Bonuses

Granting bonuses to employees and buying jet planes are perfectly legitimate for private business firms. In today’s context, this means firms that have not received government bailout money.

Giving bonuses and buying jet planes are purely business decisions. It’s only a question of whether the bonuses motivate the employees who receive them to bring in profits to the firm that are greater than the bonuses paid, or not. If the answer is yes, then it makes sense to pay the bonuses.

To the chief executive of a privately owned, non-taxpayer supported Wall Street firm, the payment of bonuses even in a year of calamitous losses may appear as still making economic sense, at least if the firm expects to stay in business. This is because the bonuses are not paid to people who have incurred the firm’s losses. Those losses are in the assets the firm owns. They are not in its day-to-day trading operations, which may continue to be profitable.

The situation is analogous to that of a retail chain which has had massive losses because of such things as fire or hurricane damage to its warehouses, but whose stores are still making money. The Wall Street firm is still executing customers’ orders in buying and selling securities, it is still trading in currencies and in the futures markets, and still arranging mergers and acquisitions, and divestitures and breakups. All of these aspects of its business may well still be profitable.

The brokers and traders, the mortgage and acquisition specialists et al., and their various assistants and supporting staffs, have contributed very substantially to these operating profits. The same is true of many of the economic and financial researchers and analysts that the firm employs in connection with its still profitable operations. Money is set aside out of the year-end totals to pay bonuses to the members of such groups, based on their respective individual profitability. The bonuses are accumulated employee compensation, similar in nature to the commissions paid to retail sales clerks. If the firm expects to be in business in the following year, and wants to retain the services of these employees, who, despite the firm’s massive losses in its accumulated assets, have performed well, it probably needs to pay them their bonuses.

John Thain, the then president of Merrill Lynch tried to explain this fact to an interviewer, when he said, “If you don’t pay your best people, you will destroy your franchise” and they’ll go elsewhere, he said.

Ms. Dowd apparently does not know the difference between an operating profit and a balance-sheet loss. She apparently does not know the difference between the due of a successful salesman in a retail-store and the due of someone whose actions have served to burn down the store’s warehouse. But she does know how to be furious. She responded to this explanation by exclaiming:

Hello? They destroyed the franchise. Let’s call their bluff. Let’s see what a great job market it is for the geniuses of capitalism who lost $15 billion in three months and helped usher in socialism.

Despite her ignorance and her collectivism-inspired refusal to draw distinctions between individuals and their respective individual performances and responsibilities, Ms. Dowd does have something of a point. Namely, if because of the bankruptcy and closing of many Wall Street firms, there should be a glut of brokers and traders et al., then the remaining Wall Street firms would be in a position to reduce their compensation. But that would be something they would typically announce before the fact, not after the fact of an agreed-upon compensation having been earned.

***

My discussion of bonuses was in the context of the operations of a privately owned business firm, not one that has to be financially supported by the government and is operated with funds provided by taxpayers. In awarding bonuses after Merrill Lynch’s receipt of government bailout money, which started in September of 2008, Mr. Thain did not realize that he was no longer in charge of a private firm. He did not realize what difference this made to the fundamental character of his firm. Neither did very many other people at the time. But more on this later.

Corporate Jets

I turn now to the subject of corporate jets.

If a corporation can afford to buy a jet and having it will enable extremely high-paid executives to avoid wasting time waiting at airports and be able to be more efficient in working in the time spent in flight, then over time its purchase may actually save more money than it costs. If so, then it will be a good business decision to buy the plane.

It may even be a good business decision to buy it, if the executives who fly in it simply prefer it because it’s more comfortable and enjoyable. In such a case, even if the plane saves nothing in costs or not enough to justify its purchase, it can still make good economic sense for the firm to buy the plane. This will be the case if it is in a position to reduce the compensation paid to the executives in question by as much or more than the amount that it must expend for their personal benefit.

Thus, for example, if the plane falls short of covering its cost through increased productivity on the part of the executives by, say, $1 million per year, the firm will have the benefit of more satisfied executives at absolutely no net cost to itself, if it gets the executives to accept $1million less per year in monetary compensation. In that way, it is the executives who effectively bear the cost of the plane that is otherwise uncovered. And the firm will have whatever indirect monetary gains that may result from better satisfied executives.

Indeed, to the extent that the executives are willing to forgo an amount of compensation that is greater than what is required to cover any otherwise uncovered cost of the plane, the firm has a clear saving in monetary terms. Thus, if the executives can be paid $2 million less per year, while the otherwise uncovered part of the cost of the plane is still $1 million, the firm has a monetary saving of $1 million per year by buying the plane. (Today’s tax laws work in this direction. The replacement of $1 million in monetary compensation with $1 million in indirect compensation, serves to reduce the executives’ after-tax monetary compensation by perhaps as little as $500 thousand, while saving the corporation the full $1 million.)

Situations such as this actually occur all the time, throughout business. Again and again, firms provide fringe benefits that are of value to their employees but which do not cover their cost through increased productivity. They are motivated to provide them by being able to save more in what they would otherwise have to pay the employees in take-home wages than the cost of the fringe benefits.

For example, imagine the situation of employees having to choose between two employers. One of them provides air conditioning. The other does not. In the heat of summer, it is a comparative pleasure to work for the one, and extremely uncomfortable to work for the other. If the employees can earn $1,000 per week by working for the employer who provides air conditioning, and they value that air condition sufficiently, then in order to be induced to work for the second employer, they might require a wage of $1,100 per week. If that second employer can provide air conditioning at a cost to himself of, say, $10 per worker per week, then he will save $90 per worker per week if he provides it. Because in that case, he can obtain his workers for a take-home wage of $1,000 plus an air-conditioning cost of $10, instead of for a take-home wage of $1,100 plus no cost on account of air conditioning. Obviously, such conditions compel the employer to provide air conditioning. It is his recognition of such conditions that led the first employer to provide air conditioning to begin with, i.e., simply because employees value having it far more than the reduction in their take-home wages that is needed to pay for it.

This discussion has application to the $1 million office remodeling that so offended Ms. Dowd. Please keep in mind that the remodeling was commissioned in late 2007, when the executive in question started his position. At that time, Merrill Lynch had not yet received any government money and was thus still a fully privately owned company. The executive in question, John Thain, was a man in charge of the use of hundreds of billions of dollars of capital. And, therefore, if he was indeed the right man for the job, which is certainly what was hoped, was easily entitled to compensation at least as far into double-digit millions as that paid to Hollywood movie stars and leading athletes.

With this many millions in compensation, the value to him of $1 million more or less, may not have been terribly great. (Hollywood stars have weddings that cost more.) It may well have been far below the value he attached to spending his hours of working time in an office that was made to personally please him in every possible respect, and which he may have expected to occupy for many years. In such a case, instead of his firm paying him however many millions it otherwise would have paid him, it could pay him a million dollars less, or even more than a million dollars less. In that case, it was he who bore the cost of the office, out of compensation to which, in the judgment of the parties concerned, he was entitled.

Alternatively, it’s entirely reasonable that providing such an office and the optimum working environment that it provided, could be expected to improve his efficiency with respect to deciding the pattern of investment of his firm’s hundreds of billions of dollars of assets. It would not have taken a great deal of such improvement with respect to the use of sums so vast to be able to earn an additional billion or more of profit for his firm. Understanding this, the firm may well have given him his office in the belief that doing so would add vastly more to its profits than the cost of the remodeling.

When Ms. Dowd discussed this million-dollar office remodeling, her reaction was one of incredulity, outrage, and utter contempt. Here’s what she said (referring to an interviewer of the executive):

Bartiromo pressed: What was wrong with the office of his predecessor, Stanley O’Neal?

‘Well — his office was very different — than — the — the general décor of — Merrill’s offices,’ Thain replied. ‘It really would have been — very difficult — for — me to use it in the form that it was in.’

Dowd then asked in a triumph akin to that of crushing a cockroach:

Did it have a desk and a phone?

I can’t help wondering, if when Dowd may need a surgical operation someday, she will be satisfied if her surgeon has a table and a knife.

Bailouts

Government bailouts put everything in a different light. They give everyone in the country the right to second guess every decision of the firms that have received the bailouts, on the grounds that the money used by those firms is theirs, the taxpayers.

Understandably, the taxpayers become furious about things like bonuses, corporate jets, and expensive office remodelings. They see themselves simply as being made to pay for these things. This is because, unlike the shareholders of a private company, the taxpayers will never have any possible financial benefit even if the expenditures might actually be perfectly reasonable and well made if they took place in the context of a privately owned company. And unlike the shareholders of a private company, they were never given a choice about whether or not they wanted their funds to be turned over to this or that company. Their funds were simply seized in order that others might have the means with which to pay bonuses and financially profit from and/or personally enjoy such things as corporate jets and expensive offices.

Bailouts represent a collision between two incompatible modes of operation—between what Mises calls “profit management” and “bureaucratic management.” That is, they represent a collision between operation according to the principle of striving to make profits and avoid losses, which characterizes private business, and operation according to the dictates of rules and regulations, which characterizes government.

The companies bailed out expected to go on operating as private businesses, but with government money. That’s how the bailouts were advertised. But that is impossible.

Once government money enters the picture, the firms are effectively nationalized, even though the outward guise and appearance of private ownership may remain. This is because their operations are no longer based on profit-and-loss considerations but on satisfying the government and whatever sectors of public opinion are loud enough at the moment to influence the government’s decisions.

What precise actions the government will take are unclear at the moment and appear contradictory. For example, the front-page lead article of The New York Times of February 5, 2009 carries the headline “Executive Pay Limits Seek to Alter Corporate Culture,” followed by the subhead, “Obama Announces a $500,000 Cash Cap at Companies Getting Future Aid.”

Nevertheless, a careful reading of the article shows that $500,000 is a limit only on annual salary. Payment of stock options will still be possible, but they will not be able to be exercised until all of the company’s debt to the government is repaid. Even the limit on annual salary appears to be not very firm. In most cases, it can apparently be waived by means of a “nonbinding shareholder vote.”

The article declares,

Even the new rules allow companies some leeway. While giving shareholders a say in bonuses above the cap and restricting when stock incentives can be cashed in, the rules do not place limits on the size of such awards, which have become the biggest part of many compensation packages. In addition, the toughest new rules apply only to large companies seeking government assistance to survive…. And companies that seek aid but do not need exceptional government assistance can waive the $500,000 pay cap, as long as they submit their executive pay policies to a nonbinding shareholder vote.

Very significantly, the article notes that

The rules would not prohibit a lower-level executive, like a stock trader or investment banker, from continuing to receive tens of millions of dollars in pay. (My italics.)

If this last is true, then one must wonder exactly what the brouhaha about bonuses was all about in the first place. Because, with this last provision, they appear to be back in, almost in full force.

The current version of the proposed pay caps is clearly contradictory and bound to disappoint Wall Street’s critics. It reads like a compromise forged of a competition between whose lobbyists could get to which politicos with the largest bribes or greatest threats first. At this point, there is no telling what the final proposal will look like. The Times’s article notes that “Officials also emphasized that several of the proposals would not be made final until after public comments had been considered.”

What would be required to satisfy the rhetoric of Wall Street’s critics would be the total abolition of bonuses and a maximum limit on total executive compensation in the nationalized firms to $500,000 for any one individual. That, of course, would mean the destruction of the nationalized firms as viable institutions.

With such a level of compensation, further discussion of such things as corporate jets and expensive office remodelings would disappear, at least as far as the nationalized firms were concerned. This is because the low pay ceilings on executive salaries, and thus the kind of low quality executives likely to be attracted, would eliminate the context in which an economic calculation could justify the purchase of a jet or an expensive office remodeling.

Executives whose salaries are limited to $500,000 are not going to be able to afford to accept the kind of reduction in take-home wages that would be necessary to cover any significant part of the cost of providing a jet or an expensive office remodeling. Nor is any enhanced productivity of such executives likely to be great enough to justify the cost. The head of a government controlled firm may inherit a luxurious office but all that he can afford or that can be afforded on his behalf is not very much more than a desk and a phone—and volumes of rules and regulations that he can consult and scrupulously follow, in order to be able to prove that whatever losses may strike his firm were not his fault.

But the destruction of bailouts is not limited to the crippling of the firms that are bailed out. It also taints the operations of the firms that are operating without bailouts. As already pointed out, they too have given up their jets and are keeping their heads down, despite the fact that economic rationality implies that they should keep their jets. They have been cowed by a raging hostility toward capitalism and wealth.

Israel prepares to vote

Israel

Israel prepares to vote

Victory for a right-leaning block is the most likely outcome of Israel’s election

THE Israeli election campaign has culminated in a neck-and-neck dash between Binyamin Netanyahu of Likud and Tzipi Livni of Kadima. In the last hours of the campaign, before voting is due to begin on Tuesday February 10th, the candidates are battling against each other and against a pervasive sense that the race is, in effect, already over. Many voters expect that the right-leaning block of parties led by Likud will handily beat the leftist block led by Kadima, and believe therefore that it does not really matter who is first past the post on Tuesday night.

Opinion polls published on Friday—the last of the campaign—suggested that the gap was steadily narrowing between “Bibi”, who was expected to get 25 or so seats in the 120-seat Knesset, and Ms Livni with 23, give-or-take a couple. Surging into third place was Yisrael Beitenu, a far-right party with a strong Russian-immigrant flavour, led by Avigdor Lieberman. It was just shy of 20 seats, leaving Labour, under Ehud Barak, the minister of defence, in fourth spot with perhaps as few as 14 seats. All the polls predicted that Likud, Yisrael Beitenu, and four small rightist-religious parties would together muster 65 or more seats, whereas Kadima, Labour and their leftist allies would have 55 or fewer.

Ms Livni has made a last-minute appeal to Israelis, especially young people, who ideally would prefer to vote for Labour or for parties farther to the left than to give their support to the somewhat eclectic collection of Likud and Labour renegades that make up Kadima. The overriding objective, she argues, is to stop Mr Netanyahu. Her only chance of doing so is if she comes in ahead of him.

Ms Livni is understandably vague about the arithmetic that would underpin her bid, after the election, to be asked by the president, Shimon Peres, to form a government. The president (who is a long-time Labourite who went over to Kadima) has a certain amount of discretion under the law, but he must be guided by the preponderance of advice tendered by the various parties.

Plainly, barring a wholly unexpected upset, Mr Lieberman will be kingmaker after the vote. Several members of Labour (although not Mr Barak himself) have solemnly promised not to sit in a government alongside Mr Lieberman, whose anti-Arab platform they deem to be racist. Ms Livni has pointedly avoided any such disqualification. On the contrary, she and her lieutenants point out that Mr Lieberman served for a time in the outgoing Kadima-led government and they suggest that, once in office, his incendiary rhetoric tends to subside.

Ms Livni’s hope is Mr Netanyahu’s fear. He was at pains during the campaign’s last hours to persuade right-leaning voters that they cannot afford the luxury of backing their various niche parties and thus risking that Likud will lose to Kadima. Mr Netanyahu needs to come first in the poll in order to ensure that he gets the mandate from Mr Peres. In an effort to persuade waverers, Mr Netanyahu suggested that “A big Likud means a stable government”, with his message plastered on thousands of billboards across the country. “Big”, of course, is relative: Likud, it seems, will command less than a quarter of the Knesset seats. “Stable”, for that reason, is likely to prove relative, too. Observers predict that even if Mr Netanyahu does manage to cobble together a coalition it will not last for long, given the wide differences between its likely elements over important questions of policy.

This reflects a growing sense among politicians and the public that the electoral system itself—proportional representation with a 2% threshold for a party to enter the assembly—is demonstrably dysfunctional. This is Israel’s fifth election in a decade.

The most consistent and radical campaigner for constitutional reform is Mr Lieberman. He has long advocated changing to a presidential system with a fixed, four-year term of office that cannot be cut short by parliamentary machinations. (He does not conceal his vision of himself as a future president.)

He may make reforming the system a condition of joining a government. Given the likelihood that neither Mr Netanyahu nor Ms Livni will be able to form a government without him, electoral reform could thus become a burning issue in Israeli politics. That is unless the two front-runners set aside their rivalry and decide to govern together, each bringing his or her allies into the coalition tent and all combining to keep Mr Lieberman out.

Obama’s ‘Screw-Up’ Leaves Geithner on Thin Ice

Obama’s ‘Screw-Up’ Leaves Geithner on Thin Ice: Caroline Baum

Commentary by Caroline Baum

Feb. 5 (Bloomberg) -- Presidential admissions of fallibility are about as common as humility on Wall Street -- until now.

“I screwed up,” Barack Obama said in TV interviews Tuesday, following Tom Daschle’s withdrawal of his nomination for Secretary of Health and Human Services. “It’s important for this administration to send a message that there aren’t two sets of rules, you know, one for prominent people and one for ordinary folks who have to pay their taxes.”

Tim Geithner must be wondering where he fits in now that principles have triumphed over personality. Geithner played by the prominent-people’s rules, cut corners on his taxes, found religion, said he was sorry, said he was sorry again, and won Senate confirmation as Treasury secretary by a vote of 60-34. It was the narrowest margin for a Treasury secretary in more than half a century.

If Obama screwed up in nominating and backing Daschle, the former Senate majority leader who ponied up $140,000 in back taxes and interest, what does that say about his support for Geithner?

Geithner (B.A., Dartmouth College, 1983; M.A. in economics, Johns Hopkins, 1985) was in arrears to the Internal Revenue Service, an agency he now heads, for $50,000. Somehow he “missed” the part in the annual hand-outs from the International Monetary Fund, his former employer, where he was told about his obligation to pay Social Security and Medicare taxes -- a document he signed annually in order to get reimbursed.

Amended Returns

After a 2006 audit by the IRS, Geithner paid back taxes for 2003 and 2004, waiting until he learned of his nomination for the Treasury to settle his 2001 and 2002 liability. (Nothing concentrates the mind like the prospect of a public hearing.)

Geithner also took a dependent-care deduction for the cost of his kid’s sleep-away camp, a creative interpretation of the tax code, to say the least. You’d think that in all those years of public service, including seven years at the Treasury, he would have run across a smart Internal Revenue Service agent who could answer his tax questions.

Like Daschle, Geithner was teed up as the only person who could possibly do the job. His major selling point was his familiarity with the Treasury’s Troubled Asset Relief Program.

TARP flunked its first and second oversight exam.

“The panel still does not know what the banks are doing with taxpayer money,” the oversight panel said in its Jan. 9 report.

Regulator Goes AWOL

As president of the Federal Reserve Bank of New York from 2003 through 2008, Geithner was at the scene of the crime when the financial system cratered. The fact that the Fed is a bank regulator and supervisor with direct responsibility for the safeness and soundness of the financial system, and that most of the big banks are in the New York Fed’s district, never posed a remote challenge to his competence or his confirmation.

Didn’t any members of the Senate Finance Committee want to know what he was doing while Citi burned?

At first it looked as if Daschle would skate through his Senate confirmation as well, his tax problems dismissed as an “innocent mistake” by his former Senate colleagues. Daschle was an early Obama supporter; the president tapped him for a dual role as secretary of HHS and health-care czar, entrusted with revamping one-seventh of the U.S. economy.

When the issue threatened to spiral out of control and distract Obama from the important business at hand, Daschle bowed out.

Business as Usual

And it was a good thing, too. Obama came to Washington pledging to drain the swamp of influence-peddling and the system of pay-to-play: You put me on the payroll, and I’ll get you a job as Commerce secretary. In addition to his tax problems, Daschle was an unregistered lobbyist who parlayed his Rolodex into a $5 million paycheck in the last four years. It sure sounds like business as usual.

Tactically it was a smart move for Obama to take responsibility for nominating and supporting a tax cheat for high office. As a practical matter, his stance creates a credibility problem for Geithner.

The economy is Obama’s No. 1 issue: getting it going, not restructuring one-seventh of it. His relationship with his Treasury secretary is almost as important as the public’s confidence in his choice.

The Treasury faces a Herculean task of fixing the banking system to stabilize the economy. It will consume trillions of dollars in new borrowing. It will require the trust and confidence of foreigners, who are bristling at the “Made in America” provision included in the $819 billion economic stimulus bill passed by the House of Representatives last week.

Trust but Verify

Geithner said as much when he appeared with Obama at a press conference yesterday.

“Financial systems are built on trust and confidence,” he said.

That’s true. Daschle started with the same premise and came to a different conclusion.

“This work will require a leader who can operate with the full faith of Congress and the American people and without distraction,” Daschle said in a statement announcing he was bowing out. “Right now, I am not that leader.”

Geithner has to be wondering if he is -- along with the rest of us.

GM, Chrysler May Face Bankruptcy to Protect U.S. Debt (Update5)

Feb. 9 (Bloomberg) -- General Motors Corp. and Chrysler LLC may have to be forced into bankruptcy by the U.S. government to assure repayment of $17.4 billion in federal bailout loans, a course of action the automakers claim would destroy them.

U.S. taxpayers currently take a backseat to prior creditors, including Citigroup Inc., JPMorgan Chase & Co. and Goldman Sachs Group Inc., according to loan agreements posted on the U.S. Treasury’s Web site. The government has hired a law firm to help establish its place at the front of the line for repayment, two people involved in the work said last week.

If federal officials fail to get a consensual agreement to change their position regarding repayment, they have the option to force the companies into bankruptcy as a condition of more bailout aid. The government would finance the bankruptcy with a so-called “debtor in possession” or DIP loan, a lender status that gives the U.S. priority over other creditors, said Don Workman, a partner at Baker & Hostetler LLP.

“They are negotiating to see if they can reach an agreement,” said Workman, a bankruptcy lawyer based in Washington. “If not, they are saying ‘We are pretty darn sure that a bankruptcy judge will allow us’” to be first in line for repayment.

GM fell 1 cent to $2.83 in New York Stock Exchange composite trading. Chrysler isn’t publicly traded.

Carmaker Opposition

The automakers have dismissed calls to reorganize under bankruptcy protection, saying a Chapter 11 restructuring would scare away buyers and lead to liquidation. They are working toward a Feb. 17 deadline to show progress on a plan put in place as part of the U.S. loans received in December from the Troubled Asset Relief Program. The companies must reduce labor costs and show how they will repay the money by next month.

GM and Chrysler are already trying to restructure out of court by cutting labor costs, reducing debt levels and eliminating dealers. GM is in talks to pare $27.5 billion in unsecured debt to about $9.2 billion in a swap for equity.

The company said it plans to shutter dealers and reduce obligations to a union retiree health fund by half to $10.2 billion in a separate equity swap. Chrysler Chief Executive Officer Robert Nardelli has said his company will also try to cut debt.

Delphi Talks

GM said today it’s in negotiations to take back portions of Delphi Corp., a parts supplier the automaker separated from a decade ago, in order to maintain portions of its supply chain. GM said it’s also considering more plant closures, job eliminations and pay cuts for administrative workers.

The automaker probably will close at least two factories, which according to the Wall Street Journal may include a truck plant in Pontiac, Michigan.

Chrysler will temporarily shut three plants, the company said last week. Those closures will be in Michigan and Canada.

January sales from automakers plunged 55 percent at Chrysler, 49 percent at GM and 40 percent at Ford Motor Co., the second-largest U.S. automaker. Ford has declined bailout funds.

The U.S. government has the option of working out an intercreditor agreement outside of bankruptcy that would give it rights to some collateral ahead of others. Such agreements, often made when money is lent to a company that already has liens on most of its assets, are usually negotiated when the loan is made.

U.S. Law Firm

Cadwalader, Wickersham & Taft LLP is advising the government on how to make sure it gets paid back first, including by way of intercreditor agreements, the people involved with the talks said. The law firm, hired last month, is working for the government with Sonnenschein, Nath & Rosenthal, a Chicago-based firm with capital-markets experience, and Rothschild Inc., an investment bank, the people said.

The issues are “extremely complex,” said Bruce Clark, a credit analyst at Moody’s Investors Service.

The existing loan agreements appear to give the banks a superior position to the government, Clark said.

“The ultimate position of the government could end up being determined by whatever concessions various creditors make, and the determination of a bankruptcy court if it ever gets there,” he said.

When the automakers were lobbying the government for assistance, lawmakers made a point of saying that the government must be assured that if the companies failed, taxpayers wouldn’t lose the investment.

Existing Lenders

Workman, who isn’t involved in the negotiations, said the U.S. couldn’t force its loans to supersede existing secured lenders, so it built in a measure that allowed the debt to be converted to debtor-in-possession financing.

“A carrot and stick approach is spot on,” he said.

As it stands, the government loans fall below existing debt secured by most assets for Auburn Hills, Michigan-based Chrysler and Detroit-based GM. Prior lenders have first position on some assets. The government has first position on assets not already pledged.

Chrysler has $7 billion in loans from a group of banks, including New York-based JPMorgan, Goldman Sachs and Citigroup. It also has $2 billion in loans from owners Cerberus Capital Management LP and Daimler AG. Cerberus owns 80.1 percent of Chrysler. Daimler owns the remainder.

GM has $6 billion in loans secured by assets from lenders including JPMorgan and Citigroup. JPMorgan spokesman Brian Marchiony, Goldman Sachs spokesman Michael Duvally and Citigroup spokeswoman Danielle Romero-Apsilos declined to comment.

Lori McTavish, a spokeswoman for Chrysler, declined to comment beyond confirming the primacy of the bank loans. Treasury spokesman Isaac Baker and GM spokeswoman Renee Rashid-Merem declined to comment. GM Vice Chairman Bob Lutz will retire at the end of 2009, the company said today in a separate statement.

Unless the automakers show by March 31 that they will be able to return to profit and repay the money, the government can demand return of the loans.

Geithner Seeks Private Investment for Toxic Assets (Update1)

Feb. 9 (Bloomberg) -- Treasury Secretary Timothy Geithner is seeking to draw investors into the U.S. financial-rescue program, aiming to add private funding as a new component of proposals to address the toxic debt clogging banks’ balance sheets.

Aides worked through the weekend to complete the package that Geithner will announce tomorrow in Washington, which was delayed by a day. Aspects of the plan that have been settled include a new round of injections of taxpayer funds into banks, targeted at those identified by regulators as most in need of new capital, people briefed on the matter said.

The toughest issue has been the one Geithner’s predecessor failed to address: the illiquid assets that caused the credit crunch. A leading proposal is a so-called aggregator bank, featuring investors such as hedge funds and private equity, that may issue Federal Deposit Insurance Corp.-backed debt, the people said. It’s unclear how big a role there will be for guarantees of securities that stay on banks’ balance sheets.

“We have to reach a point where investors and consumers have greater confidence in our financial system,” Philadelphia Federal Reserve Bank President Charles Plosser said in an interview. “Without that, these institutions will not be able to attract new capital or be able to fully resume their important role in providing credit.”

Stimulus Package

Officials said yesterday the one-day delay was to allow the administration to focus on getting Senate approval of President Barack Obama’s fiscal stimulus. Geithner is scheduled to unveil the effort at 11 a.m. tomorrow.

A Federal Reserve program designed to spur consumer and small-business loans will be expanded as part of tomorrow’s package, possibly to include real-estate assets, the people said.

For now, the government doesn’t intend to ask for more money, while leaving open the option of requesting more later. Most of the second half of the $700 billion Troubled Asset Relief Program has yet to be allocated, an amount that economists have said is unequal to the task of shoring up the financial industry.

“Credit markets in this country are not working right” and “we’ll do what is necessary” to start a process of repair, Lawrence Summers, director of the White House National Economic Council, said on ABC television’s This Week program yesterday. Asked if the administration may come back to ask for more money down the road he said “we’ll see what happens.”

Stress Tests

Regulators plan to subject banks deemed most important to the financial system’s stability to a new test to determine whether they have enough capital, according to a person familiar with the matter. The President’s Working Group on financial markets, which includes the Fed, FDIC, Securities and Exchange Commission and Commodity Futures Trading Commission, will develop the examination’s guidelines, the person said.

Firms that fail the test will receive more capital injections from the government, the person said. Banks that couldn’t repay the money over a period of time could be liquidated, placed into receivership or have their assets retired by officials over time.

Geithner will try to sell the plan as a clean break from the Bush administration, while offering many of the same programs and policy tools bequeathed by former Secretary Henry Paulson.

Capital Injections

The round of equity injections planned will contrast with Paulson’s initial push to make new capital available to all banks, and the firms that get additional money will be faced with tougher terms, people briefed on the matter said.

“We’ve got to characterize this not as saving the banks, but saving the economy in terms of the credit that flows in this country,” Senator Claire McCaskill, a Missouri Democrat, said yesterday on NBC’s Meet the Press.

The FDIC is expected to play a role either running or financing some bad bank type of unit that takes on illiquid securities, which may sell its own government-backed debt, the people said.

Also this week, officials may seek to boost the FDIC’s credit line with the Treasury to $100 billion from $30 billion. The FDIC’S deposit-insurance fund is diminishing as it takes on more failed banks.

Geithner’s plan may include an asset-guarantee element similar to previous deals arranged for Citigroup Inc. and Bank of America Corp., while it’s not clear how big a role such insurance would play in tomorrow’s announcement, the people said.

Congressional Criticism

The new approach comes four months after the start of the $700 billion TARP, which both Democrats and Republicans have criticized as ineffective. The task Geithner faces is reviving a U.S. banking system throttled by $752 billion in credit losses and an economy that lost almost 600,000 jobs last month.

Economic news this week is expected to show a further deterioration. Sales at U.S. retailers probably fell in January for a seventh straight month, capping the longest slide since comparable records began in 1992. The Commerce Department report will probably show purchases declined 0.8 percent, according to the median estimate in a Bloomberg News survey.

A Labor Department report last week showed the U.S. unemployment rate climbed to 7.6 percent, its highest level since 1992. White House Council of Economic Advisers Chairman Christina Romer warned last week that the rate may climb to 10 percent or higher without approval of Obama’s stimulus package, which exceeds $800 billion.

Stock Slump

With the economic downturn deepening, attracting private money to the financial industry may be difficult. The Standard and Poor’s 500 Banks Index has fallen 33 percent since the start of last month, and 65 percent in the past year. It rose today, closing at 91.20.

Bank of America plunged 57 percent in the past month, closing at $6.58 last week even after the government agreed to backstop a portfolio of more than $100 billion of its assets. Citigroup, which got a joint federal guarantee for investments in excess of $300 billion, closed at $3.91.

The Obama administration will seek to “catalyze and spur private investment” to help solve the crisis, Summers said in an interview on Fox News Sunday.

Banks are “looking for clarity, we’re looking for this to be the complete package,” said Wayne Abernathy, an executive vice president at the American Bankers Association in Washington. “If they don’t have the details spelled out they will just freeze the market.”

Housing programs will be a key element of the administration’s plan, though may be announced separately from the bank-rescue rollout. House Financial Services Committee Chairman Barney Frank said yesterday that Obama will steer “substantial” funds to stem foreclosures as the administration prepares to unveil its plan for stabilizing the economy.

“A major part of what you’re going to see from the Obama administration is an effort to put substantial money into reducing foreclosures,” Frank, a Massachusetts Democrat, said on NBC’s “Meet the Press.”

Railing Against the Rich

Railing Against the Rich: A Great American Tradition

Efforts to limit pay of the wealthiest gained traction in the 1930s; 'economic royalists'

ALAN BRINKLEY

The Great Depression of the 1930s created hardship and suffering among millions of Americans. It also created populist resentment of elites. Among the many signs of this anger was the astonishing popularity of Huey P. Long, governor of Louisiana and then U.S. senator, a figure so dominant in his own state that his enemies called him a dictator. But to the ordinary people of Louisiana -- and later to millions of ordinary people across the U.S. -- Mr. Long was a heroic figure, fighting for the "common man" and challenging the right of elites to monopolize power and wealth.

Starting in 1933, Mr. Long created a national organization called the "Share Our Wealth Society." He publicized it through his frequent national radio broadcasts (with time provided free by timid network executives), and through his many speeches before many audiences. His goal, he claimed, was a radical redistribution of wealth. Every needy American would receive a "household estate" of $5,000 (almost $80,000 in 2008 dollars), an annual wage of $2,500 ($40,000 in 2008 dollars), and other benefits. This great boon would be financed by high taxes on people making over $1 million. There would be an $8 million cap, with everything above that confiscated for redistribution. The plan was economically, and probably politically, impossible. But the inability of a wealthy nation to provide jobs and support to millions of citizens made Mr. Long's proposal appealing and persuasive. "Let no one tell you that it is difficult to redistribute the wealth of this land," he told a radio audience in 1934. "It is simple."

Whether or not we are now entering a new Great Depression, we are almost certainly entering a period in which resentment of financial and corporate titans will increase, and in which many politicians will feel they have no choice but to join the chorus of denunciation -- perhaps even a president with almost unprecedented approval ratings as he begins his term. In the 1930s, the popularity of "big business" -- high in the prosperous 1920s -- dropped dramatically, even catastrophically, and did not revive until the corporate world recovered its wealth in World War II. In the meantime, the wealthy and powerful encountered challenges that make President Barack Obama's $500,000 salary cap on companies seeking federal assistance seem pale by comparison.

Photo by General Photographic Agency/Getty Images)

Huey P. Long

In the 1930s, plans similar to Mr. Long's proliferated and attracted broad support. Francis Townsend, an aging physician in Long Beach, Calif., launched the Townsend Plan, a promise to everyone over 60 of a guaranteed $150 to $200 a month from the government "on condition that they spend the money as they get it." A nationwide "transaction tax" (similar to a V.A.T.) would, he improbably argued, provide enough money to finance the system. Dr. Townsend claimed that he had up to 25 million followers two years after launching his plan -- an unverifiable but not impossible number. The novelist Upton Sinclair almost won election as governor of California in 1934 by proposing the seizure of idle factories and farms from their capitalist owners. The properties would be managed as cooperatives to give work to the unemployed and to replace the profit system with what he called "production for use." Father Charles Coughlin of Detroit, known as the "radio priest" for his weekly political broadcast, chastised bankers and financiers and demanded a radical inflation of the currency -- an old populist proposal that Father Coughlin insisted would redistribute wealth.

Franklin Roosevelt himself, trying to steal the thunder of the populists, proposed the so-called "soak-the-rich" tax, passed in 1935, which targeted high corporate salaries and investment income, even though it did little to increase government revenues or reduce the real wealth of those required to pay. He made a series of speeches in 1936 excoriating the selfishness and greed of the "economic royalists." He had struggled, he said, "with the old enemies of peace, business and financial monopoly, speculation, reckless banking, class antagonism, sectionalism, war profiteering…. Never before in all our history have these forces been so united against one candidate as they stand today. They are unanimous in their hate for me, and I welcome their hatred." This polarizing rhetoric was greeted with some of the most enthusiastic responses of any of his speeches.

In the end, this powerful, anti-capitalist populism had relatively little impact on economic life. Mr. Long was assassinated in 1935. Mr. Sinclair lost his election. Father Coughlin and Dr. Townsend joined forces in a third-party presidential challenge in 1936, an effort that received less than 2% of the vote in an election Roosevelt won by a landslide. Few New Deal measures bore any significant relationship to the proposals from these populist movements, although some historians believe that the Townsend Plan helped spur passage of the 1935 Social Security Act. A few years later, the New Deal abandoned its anti-business rhetoric in the face of a deepening recession. Instead, the government began to embrace Keynesian solutions, which promised economic growth through increased government spending, a strategy that required no significant intrusion into the prerogatives of capitalists.

The Great Depression may not have significantly weakened the power and wealth of the "economic royalists," but the animus toward them was not without consequences. The utilities magnate Samuel Insull fled the country to avoid prosecution for fraud, only to be extradited back to the U.S. to stand trial, where he was marched in and out of court in handcuffs. (He was ultimately acquitted.) Sewell Avery, the president of Montgomery Ward, was carried out of his office by police during a 1944 labor dispute; a photograph of the event was one of the most widely published in the nation. There was a special gleefulness among much of the public in seeing once-powerful titans fall, as many of them did. Even those who flourished bridled at the rhetoric used against them.

As late as 1940, 11 years after the Depression began, images of brutal and greedy capitalists remained staples of popular culture. John Steinbeck's 1939 novel "The Grapes of Wrath," and the John Ford film adaptation a year later, were great popular successes, not despite but because of their harsh denunciations of capitalists and their flunkies. Tom Joad, a young man politicized by the Depression, leaves his family after killing a strikebreaker (an act neither Steinbeck nor Ford condemned), but not before making a classically radical-populist prophecy: "Wherever there's a fight so hungry people can eat, I'll be there. Wherever there's a cop beatin' up a guy, I'll be there…. An' when our folks eat the stuff they raise an' live in the houses they build -- why I'll be there."

Few 21st-century Americans have any real experience with economic populism. That appears to be changing fast. In the 1930s, the demonization of the upper class did not really begin until almost two years after the stock-market crash. We are now six months into our own economic crisis, and signs of populist resentment are already visible: in the perverse fascination with Bernard Madoff's remarkable fraud, the popular outrage at the tax problems of public officials, the growing contempt for the many overseers of the credit markets, the ruined investments of millions of ordinary people, the growing army of the unemployed (still far below the 15% to 25% unemployment of the 1930s, but 7.6% in January and growing fast), the likelihood of a recession that could last not just for months, but for years. These are the preconditions of populist revolts. Mr. Obama's chastisements of bankers and CEOs have been relatively mild compared to the routine denunciations of "economic royalists" in the 1930s. But the longer the crisis goes on and the deeper it grows, the more Huey Long-like challenges to those in power will arise, and the more pressure there will be for national leaders to launch populist battles of their own.

Whether that would help or hurt the Obama administration is hard to predict. In 1896, in the midst of another great depression, the Democratic party chose as its candidate the great populist hero William Jennings Bryan. His crushing defeat ushered in 36 years of almost unbroken Republican rule. In 1936, at the height of Franklin Roosevelt's populist rhetoric, his landslide re-election helped solidify a comparable period of Democratic dominance. Cultural populism has been a staple of the right since at least 1968, and it has alternately helped, and badly hurt, conservative candidates and causes. Economic populism has the same capacity either to bring down the president's ambitious agenda or, if handled skillfully, to open up opportunities for greater change than he may yet have imagined.

Alan Brinkley is the Allan Nevins professor of history and the provost at Columbia University.

POLICE, COURTS, AND LAWS---ON THE MARKET

How, without government, could we settle the disputes that are now settled in courts of law? How could we protect ourselves from criminals?

Consider first the easiest case, the resolution of disputes involving contracts between well-established firms. A large fraction of such disputes are now settled not by government courts but by private arbitration of the sort described in Chapter 18. The firms, when they draw up a contract, specify a procedure for arbitrating any dispute that may arise. Thus they avoid the expense and delay of the courts.

The arbitrator has no police force. His function is to render decisions, not to enforce them. Currently, arbitrated decisions are usually enforceable in the government courts, but that is a recent development; historically, enforcement came from a firm's desire to maintain its reputation. After refusing to accept an arbitrator's judgment, it is hard to persuade anyone else to sign a contract that specifies arbitration; no one wants to play a game of 'heads you win, tails I lose'.

Arbitration arrangements are already widespread. As the courts continue to deteriorate, arbitration will continue to grow. But it only provides for the resolution of disputes over pre-existing contracts. Arbitration, by itself, provides no solution for the man whose car is dented by a careless driver, still less for the victim of theft; in both cases the plaintiff and defendant, having different interests and no prior agreement, are unlikely to find a mutually satisfactory arbitrator. Indeed, the defendant has no reason to accept any arbitration at all; he can only lose--which brings us to the problem of preventing coercion.

Protection from coercion is an economic good. It is presently sold in a variety of forms--Brinks guards, locks, burglar alarms. As the effectiveness of government police declines, these market substitutes for the police, like market substitutes for the courts, become more popular.

Suppose, then, that at some future time there are no government police, but instead private protection agencies. These agencies sell the service of protecting their clients against crime. Perhaps they also guarantee performance by insuring their clients against losses resulting from criminal acts.

How might such protection agencies protect? That would be an economic decision, depending on the'-costs and effectiveness of different alternatives. On the one extreme, they might limit themselves to passive defenses, installing elaborate locks and alarms. Or they might take no preventive action at all, but make great efforts to hunt down criminals guilty of crimes against their clients. They might maintain foot patrols or squad cars, like our present government police, or they might rely on electronic substitutes. In any case, they would be selling a service to their customers and would have a strong incentive to provide as high a quality of service as possible, at the lowest possible cost. It is reasonable to suppose that the quality of service would be higher and the cost lower than with the present governmental system.

Inevitably, conflicts would arise between one protective agency and another. How might they be resolved?

I come home one night and find my television set missing. I immediately call my protection agency, Tannahelp Inc., to report the theft. They send an agent. He checks the automatic camera which Tannahelp, as part of their service, installed in my living room and discovers a picture of one Joe Bock lugging the television set out the door. The Tannahelp agent contacts Joe, informs him that Tannahelp has reason to believe he is in possession of my television set, and suggests he return it, along with an extra ten dollars to pay for Tannahelp's time and trouble in locating Joe. Joe replies that he has never seen my television set in his life and tells the Tannahelp agent to go to hell.

The agent points out that until Tannahelp is convinced there has been a mistake, he must proceed on the assumption that the television set is my property. Six Tannahelp employees, all large and energetic, will be at Joe's door next morning to collect the set. Joe, in response, informs the agent that he also has a protection agency, Dawn Defense, and that his contract with them undoubtedly requires them to protect him if six goons try to break into his house and steal his television set.

The stage seems set for a nice little war between Tannahelp and Dawn Defense. It is precisely such a possibility that has led some libertarians who are not anarchists, most notably Ayn Rand, to reject the possibility of competing free-market protection agencies.

But wars are very expensive, and Tannahelp and Dawn Defense are both profit-making corporations, more interested in saving money than face. I think the rest of the story would be less violent than Miss Rand supposed.

The Tannahelp agent calls up his opposite number at Dawn Defense. 'We've got a problem. . . .' After explaining the situation, he points out that if Tannahelp sends six men and Dawn eight, there will be a fight. Someone might even get hurt. Whoever wins, by the time the conflict is over it will be expensive for both sides. They might even have to start paying their employees higher wages to make up for the risk. Then both firms will be forced to raise their rates. If they do, Murbard Ltd., an aggressive new firm which has been trying to get established in the area, will undercut their prices and steal their customers. There must be a better solution.

The man from Tannahelp suggests that the better solution is arbitration. They will take the dispute over my television set to a reputable local arbitration firm. If the arbitrator decides that Joe is innocent, Tannahelp agrees to pay Joe and Dawn Defense an indemnity to make up for their time and trouble. If he is found guilty, Dawn Defense will accept the verdict; since the television set is not Joe's, they have no obligation to protect him when the men from Tannahelp come to seize it.

What I have described is a very makeshift arrangement. In practice, once anarcho-capitalist institutions were well established, protection agencies would anticipate such difficulties and arrange contracts in advance, before specific conflicts occurred, specifying the arbitrator who would settle them.

In such an anarchist society, who would make the laws? On what basis would the private arbitrator decide what acts were criminal and what their punishments should be? The answer is that systems of law would be produced for profit on the open market, just as books and bras are produced today. There could be competition among different brands of law, just as there is competition among different brands of cars.

In such a society there might be many courts and even many legal systems. Each pair of protection agencies agree in advance on which court they will use in case of conflict. Thus the laws under which a particular case is decided are determined implicitly by advance agreement between the protection agencies whose customers are involved. In principle, there could be a different court and a different set of laws for every pair of protection agencies. In practice, many agencies would probably find it convenient to patronize the same courts, and many courts might find it convenient to adopt identical, or nearly identical, systems of law in order to simplify matters for their customers.

Before labelling a society in which different people are under different laws chaotic and unjust, remember that in our society the law under which you are judged depends on the country, state, and even city in which you happen to be. Under the arrangements I am describing, it depends instead on your protective agency and the agency of the person you accuse of a crime or who accuses you of a crime.

In such a society law is produced on the market. A court supports itself by charging for the service of arbitrating disputes. Its success depends on its reputation for honesty, reliability, and promptness and on the desirability to potential customers of the particular set of laws it judges by. The immediate customers are protection agencies. But the protection agency is itself selling a product to its customers. Part of that product is the legal system, or systems, of the courts it patronizes and under which its customers will consequently be judged. Each protection agency will try to patronize those courts under whose legal system its customers would like to live.

Consider, as a particular example, the issue of capital punishment. Some people might feel that the risk to themselves of being convicted, correctly or incorrectly, and executed for a capital crime outweighed any possible advantages of capital punishment. They would prefer, where possible, to patronize protection agencies that patronized courts that did not give capital punishment. Other citizens might feel that they would be safer from potential murderers if it was known that anyone who murdered them would end up in the electric chair. They might consider that safety more important than the risk of ending up in the electric chair themselves or of being responsible for the death of an innocent accused of murder. They would, if possible, patronize agencies that patronized courts that did give capital punishment.

If one position or the other is almost universal, it may pay all protection agencies to use courts of the one sort or the other. If some people feel one way and some the other, and if their feelings are strong enough to affect their choice of protection agencies, it pays some agencies to adopt a policy of guaranteeing, whenever possible, to use courts that do not recognize capital punishment. They can then attract anti-capital-punishment customers. Other agencies do the opposite.

Disputes between two anti-capital-punishment agencies will, of course, go to an anti-capital-punishment court; disputes between two pro-capital-punishment agencies will go to a pro-capital-punishment court. What would happen in a dispute between an anti-capital-punishment agency and a pro-capital-punishment agency? Obviously there is no way that if I kill you the case goes to one court, but if you are killed by me it goes to another. We cannot each get exactly the law we want.

We can each have our preferences reflected in the bargaining demands of our respective agencies. If the opponents of capital punishment feel more strongly than the proponents, the agencies will agree to no capital punishment; in exchange, the agencies that want capital punishment will get something else. Perhaps it will be agreed that they will not pay court costs or that some other disputed policy will go their way.

One can imagine an idealized bargaining process, for this or any other dispute, as follows: Two agencies are negotiating whether to recognize a pro- or anti-capital-punishment court. The pro agency calculates that getting a pro-capital-punishment court will be worth $20,000 a year to its customers; that is the additional amount it can get for its services if they include a guarantee of capital punishment in case of disputes with the other agency. The anti-capital-punishment agency calculates a corresponding figure of $40,000. It offers the pro agency $30,000 a year in exchange for accepting an anti-capital-punishment court. The pro agency accepts. Now the anti-capital-punishment agency can raise its rates enough to bring in an extra $35,000. Its customers are happy, since the guarantee of no capital punishment is worth more than that. The agency is happy; it is getting an extra $5,000 a year profit. The pro agency cuts its rates by an amount that costs it $25,000 a year. This lets it keep its customers and even get more, since the savings is more than enough to make up to them for not getting the court of their choice. It, too, is making a $5,000 a year profit on the transaction. As in any good trade, everyone gains.

If you find this confusing, it may be worth the trouble of going over it again; the basic principle of such negotiation will become important later when I discuss what sort of law an anarcho-capitalist society is likely to have.

If, by some chance, the customers of the two agencies feel equally strongly, perhaps two courts will be chosen, one of each kind, and cases allocated randomly between them. In any case, the customer's legal preference, his opinion as to what sort of law he wishes to live under, will have been a major factor in determining the kind of law he does live under. It cannot completely determine it, since accused and accuser must have the same law.

In the case of capital punishment, the two positions are directly opposed. Another possibility is that certain customers may want specialized law, suited to their special circumstances. People living in desert areas might want a system of law that very clearly defines property rights in water. People in other areas would find such detailed treatment of this problem superfluous at best. At worst, it might be the source of annoying nuisance suits. Thus the desert people might all patronize one protection agency, which had a policy of always going to a court with well-developed water law. Other agencies would agree to use that court in disputes with that agency but use other courts among themselves.

Most differences among courts would probably be more subtle. People would find that the decisions of one court were prompter or easier to predict than those of another or that the customers of one protection agency were better protected than those of another. The protection agencies, trying to build their own reputations, would search for the 'best' courts.

Several objections may be raised to such free-market courts. The first is that they would sell justice by deciding in favor of the highest bidder. That would be suicidal; unless they maintained a reputation for honesty, they would have no customers--unlike our present judges. Another objection is that it is the business of courts and legislatures to discover laws, not create them; there cannot be two competing laws of gravity, so why should there be two competing laws of property? But there can be two competing theories about the law of gravity or the proper definition of property rights. Discovery is as much a productive activity as creation. If it is obvious what the correct law is, what rules of human interaction follow from the nature of man, then all courts will agree, just as all architects agree about the laws of physics. If it is not obvious, the market will generate research intended to discover correct laws.

Another objection is that a society of many different legal systems would be confusing. If this is found to be a serious problem, courts will have an economic incentive to adopt uniform law, just as paper companies have an incentive to produce standardized sizes of paper. New law will be introduced only when the innovator believes that its advantages outweigh the advantages of uniformity.

The most serious objection to free-market law is that plaintiff and defendant may not be able to agree on a common court. Obviously, a murderer would prefer a lenient judge. If the court were actually chosen by the disputants after the crime occurred, this might be an insuperable difficulty. Under the arrangements I have described, the court is chosen in advance by the protection agencies. There would hardly be enough murderers at any one time to support their own protective agency, one with a policy of patronizing courts that did not regard murder as a crime. Even if there were, no other protective agency would accept such courts. The murderers' agency would either accept a reasonable court or fight a hopeless war against the rest of society.

Until he is actually accused of a crime, everyone wants laws that protect him from crime and let him interact peacefully and productively with others. Even criminals. Not many murderers would wish to live under laws that permitted them to kill--and be killed.

How, without government, could we settle the disputes that are now settled in courts of law? How could we protect ourselves from criminals?

Consider first the easiest case, the resolution of disputes involving contracts between well-established firms. A large fraction of such disputes are now settled not by government courts but by private arbitration of the sort described in Chapter 18. The firms, when they draw up a contract, specify a procedure for arbitrating any dispute that may arise. Thus they avoid the expense and delay of the courts.

The arbitrator has no police force. His function is to render decisions, not to enforce them. Currently, arbitrated decisions are usually enforceable in the government courts, but that is a recent development; historically, enforcement came from a firm's desire to maintain its reputation. After refusing to accept an arbitrator's judgment, it is hard to persuade anyone else to sign a contract that specifies arbitration; no one wants to play a game of 'heads you win, tails I lose'.

Arbitration arrangements are already widespread. As the courts continue to deteriorate, arbitration will continue to grow. But it only provides for the resolution of disputes over pre-existing contracts. Arbitration, by itself, provides no solution for the man whose car is dented by a careless driver, still less for the victim of theft; in both cases the plaintiff and defendant, having different interests and no prior agreement, are unlikely to find a mutually satisfactory arbitrator. Indeed, the defendant has no reason to accept any arbitration at all; he can only lose--which brings us to the problem of preventing coercion.

Protection from coercion is an economic good. It is presently sold in a variety of forms--Brinks guards, locks, burglar alarms. As the effectiveness of government police declines, these market substitutes for the police, like market substitutes for the courts, become more popular.

Suppose, then, that at some future time there are no government police, but instead private protection agencies. These agencies sell the service of protecting their clients against crime. Perhaps they also guarantee performance by insuring their clients against losses resulting from criminal acts.

How might such protection agencies protect? That would be an economic decision, depending on the'-costs and effectiveness of different alternatives. On the one extreme, they might limit themselves to passive defenses, installing elaborate locks and alarms. Or they might take no preventive action at all, but make great efforts to hunt down criminals guilty of crimes against their clients. They might maintain foot patrols or squad cars, like our present government police, or they might rely on electronic substitutes. In any case, they would be selling a service to their customers and would have a strong incentive to provide as high a quality of service as possible, at the lowest possible cost. It is reasonable to suppose that the quality of service would be higher and the cost lower than with the present governmental system.

Inevitably, conflicts would arise between one protective agency and another. How might they be resolved?

I come home one night and find my television set missing. I immediately call my protection agency, Tannahelp Inc., to report the theft. They send an agent. He checks the automatic camera which Tannahelp, as part of their service, installed in my living room and discovers a picture of one Joe Bock lugging the television set out the door. The Tannahelp agent contacts Joe, informs him that Tannahelp has reason to believe he is in possession of my television set, and suggests he return it, along with an extra ten dollars to pay for Tannahelp's time and trouble in locating Joe. Joe replies that he has never seen my television set in his life and tells the Tannahelp agent to go to hell.

The agent points out that until Tannahelp is convinced there has been a mistake, he must proceed on the assumption that the television set is my property. Six Tannahelp employees, all large and energetic, will be at Joe's door next morning to collect the set. Joe, in response, informs the agent that he also has a protection agency, Dawn Defense, and that his contract with them undoubtedly requires them to protect him if six goons try to break into his house and steal his television set.

The stage seems set for a nice little war between Tannahelp and Dawn Defense. It is precisely such a possibility that has led some libertarians who are not anarchists, most notably Ayn Rand, to reject the possibility of competing free-market protection agencies.

But wars are very expensive, and Tannahelp and Dawn Defense are both profit-making corporations, more interested in saving money than face. I think the rest of the story would be less violent than Miss Rand supposed.

The Tannahelp agent calls up his opposite number at Dawn Defense. 'We've got a problem. . . .' After explaining the situation, he points out that if Tannahelp sends six men and Dawn eight, there will be a fight. Someone might even get hurt. Whoever wins, by the time the conflict is over it will be expensive for both sides. They might even have to start paying their employees higher wages to make up for the risk. Then both firms will be forced to raise their rates. If they do, Murbard Ltd., an aggressive new firm which has been trying to get established in the area, will undercut their prices and steal their customers. There must be a better solution.

The man from Tannahelp suggests that the better solution is arbitration. They will take the dispute over my television set to a reputable local arbitration firm. If the arbitrator decides that Joe is innocent, Tannahelp agrees to pay Joe and Dawn Defense an indemnity to make up for their time and trouble. If he is found guilty, Dawn Defense will accept the verdict; since the television set is not Joe's, they have no obligation to protect him when the men from Tannahelp come to seize it.

What I have described is a very makeshift arrangement. In practice, once anarcho-capitalist institutions were well established, protection agencies would anticipate such difficulties and arrange contracts in advance, before specific conflicts occurred, specifying the arbitrator who would settle them.

In such an anarchist society, who would make the laws? On what basis would the private arbitrator decide what acts were criminal and what their punishments should be? The answer is that systems of law would be produced for profit on the open market, just as books and bras are produced today. There could be competition among different brands of law, just as there is competition among different brands of cars.

In such a society there might be many courts and even many legal systems. Each pair of protection agencies agree in advance on which court they will use in case of conflict. Thus the laws under which a particular case is decided are determined implicitly by advance agreement between the protection agencies whose customers are involved. In principle, there could be a different court and a different set of laws for every pair of protection agencies. In practice, many agencies would probably find it convenient to patronize the same courts, and many courts might find it convenient to adopt identical, or nearly identical, systems of law in order to simplify matters for their customers.

Before labelling a society in which different people are under different laws chaotic and unjust, remember that in our society the law under which you are judged depends on the country, state, and even city in which you happen to be. Under the arrangements I am describing, it depends instead on your protective agency and the agency of the person you accuse of a crime or who accuses you of a crime.

In such a society law is produced on the market. A court supports itself by charging for the service of arbitrating disputes. Its success depends on its reputation for honesty, reliability, and promptness and on the desirability to potential customers of the particular set of laws it judges by. The immediate customers are protection agencies. But the protection agency is itself selling a product to its customers. Part of that product is the legal system, or systems, of the courts it patronizes and under which its customers will consequently be judged. Each protection agency will try to patronize those courts under whose legal system its customers would like to live.

Consider, as a particular example, the issue of capital punishment. Some people might feel that the risk to themselves of being convicted, correctly or incorrectly, and executed for a capital crime outweighed any possible advantages of capital punishment. They would prefer, where possible, to patronize protection agencies that patronized courts that did not give capital punishment. Other citizens might feel that they would be safer from potential murderers if it was known that anyone who murdered them would end up in the electric chair. They might consider that safety more important than the risk of ending up in the electric chair themselves or of being responsible for the death of an innocent accused of murder. They would, if possible, patronize agencies that patronized courts that did give capital punishment.

If one position or the other is almost universal, it may pay all protection agencies to use courts of the one sort or the other. If some people feel one way and some the other, and if their feelings are strong enough to affect their choice of protection agencies, it pays some agencies to adopt a policy of guaranteeing, whenever possible, to use courts that do not recognize capital punishment. They can then attract anti-capital-punishment customers. Other agencies do the opposite.

Disputes between two anti-capital-punishment agencies will, of course, go to an anti-capital-punishment court; disputes between two pro-capital-punishment agencies will go to a pro-capital-punishment court. What would happen in a dispute between an anti-capital-punishment agency and a pro-capital-punishment agency? Obviously there is no way that if I kill you the case goes to one court, but if you are killed by me it goes to another. We cannot each get exactly the law we want.

We can each have our preferences reflected in the bargaining demands of our respective agencies. If the opponents of capital punishment feel more strongly than the proponents, the agencies will agree to no capital punishment; in exchange, the agencies that want capital punishment will get something else. Perhaps it will be agreed that they will not pay court costs or that some other disputed policy will go their way.

One can imagine an idealized bargaining process, for this or any other dispute, as follows: Two agencies are negotiating whether to recognize a pro- or anti-capital-punishment court. The pro agency calculates that getting a pro-capital-punishment court will be worth $20,000 a year to its customers; that is the additional amount it can get for its services if they include a guarantee of capital punishment in case of disputes with the other agency. The anti-capital-punishment agency calculates a corresponding figure of $40,000. It offers the pro agency $30,000 a year in exchange for accepting an anti-capital-punishment court. The pro agency accepts. Now the anti-capital-punishment agency can raise its rates enough to bring in an extra $35,000. Its customers are happy, since the guarantee of no capital punishment is worth more than that. The agency is happy; it is getting an extra $5,000 a year profit. The pro agency cuts its rates by an amount that costs it $25,000 a year. This lets it keep its customers and even get more, since the savings is more than enough to make up to them for not getting the court of their choice. It, too, is making a $5,000 a year profit on the transaction. As in any good trade, everyone gains.

If you find this confusing, it may be worth the trouble of going over it again; the basic principle of such negotiation will become important later when I discuss what sort of law an anarcho-capitalist society is likely to have.

If, by some chance, the customers of the two agencies feel equally strongly, perhaps two courts will be chosen, one of each kind, and cases allocated randomly between them. In any case, the customer's legal preference, his opinion as to what sort of law he wishes to live under, will have been a major factor in determining the kind of law he does live under. It cannot completely determine it, since accused and accuser must have the same law.

In the case of capital punishment, the two positions are directly opposed. Another possibility is that certain customers may want specialized law, suited to their special circumstances. People living in desert areas might want a system of law that very clearly defines property rights in water. People in other areas would find such detailed treatment of this problem superfluous at best. At worst, it might be the source of annoying nuisance suits. Thus the desert people might all patronize one protection agency, which had a policy of always going to a court with well-developed water law. Other agencies would agree to use that court in disputes with that agency but use other courts among themselves.

Most differences among courts would probably be more subtle. People would find that the decisions of one court were prompter or easier to predict than those of another or that the customers of one protection agency were better protected than those of another. The protection agencies, trying to build their own reputations, would search for the 'best' courts.

Several objections may be raised to such free-market courts. The first is that they would sell justice by deciding in favor of the highest bidder. That would be suicidal; unless they maintained a reputation for honesty, they would have no customers--unlike our present judges. Another objection is that it is the business of courts and legislatures to discover laws, not create them; there cannot be two competing laws of gravity, so why should there be two competing laws of property? But there can be two competing theories about the law of gravity or the proper definition of property rights. Discovery is as much a productive activity as creation. If it is obvious what the correct law is, what rules of human interaction follow from the nature of man, then all courts will agree, just as all architects agree about the laws of physics. If it is not obvious, the market will generate research intended to discover correct laws.

Another objection is that a society of many different legal systems would be confusing. If this is found to be a serious problem, courts will have an economic incentive to adopt uniform law, just as paper companies have an incentive to produce standardized sizes of paper. New law will be introduced only when the innovator believes that its advantages outweigh the advantages of uniformity.

The most serious objection to free-market law is that plaintiff and defendant may not be able to agree on a common court. Obviously, a murderer would prefer a lenient judge. If the court were actually chosen by the disputants after the crime occurred, this might be an insuperable difficulty. Under the arrangements I have described, the court is chosen in advance by the protection agencies. There would hardly be enough murderers at any one time to support their own protective agency, one with a policy of patronizing courts that did not regard murder as a crime. Even if there were, no other protective agency would accept such courts. The murderers' agency would either accept a reasonable court or fight a hopeless war against the rest of society.

Until he is actually accused of a crime, everyone wants laws that protect him from crime and let him interact peacefully and productively with others. Even criminals. Not many murderers would wish to live under laws that permitted them to kill--and be killed.

THE LIBERTARIAN

Monday, February 9, 2009

WALL STREET; MEET YOUR NEW BOSS

There's No Stimulus Free Lunch

There's No Stimulus Free Lunch

It's hard to spend wise and spend fast.

GARY S. BECKER KEVIN M. MURPHY

Pelosi's Indefensible Bill

Pelosi's Indefensible Bill

For Barack Obama, a cautionary tale of audacity.

By WILLIAM MCGURN

There Is Room for Rate Cuts

There Is Room for Rate Cuts

The euro will not only survive the crisis, but will also become more attractive for new countries in the future.

PEDRO SOLBES

Judge Napolitano on Glenn Beck 02/09/2009

Tom Woods on Glenn Beck "Meltdown" 02/09/2009

Official figures obscure China's decline

Joe McDonald ASSOCIATED PRESS

The Action Americans Need

The Action Americans Need

New York Times Columnist Maureen Dowd Wants Soviet-Style Show Trials with Capitalist Defendants in Shackles

New York Times Columnist Maureen Dowd Wants Soviet-Style Show Trials with Capitalist Defendants in Shackles

Israel prepares to vote

Israel prepares to vote

Victory for a right-leaning block is the most likely outcome of Israel’s election

Obama’s ‘Screw-Up’ Leaves Geithner on Thin Ice

GM, Chrysler May Face Bankruptcy to Protect U.S. Debt (Update5)

Geithner Seeks Private Investment for Toxic Assets (Update1)

Railing Against the Rich

Railing Against the Rich: A Great American Tradition

Efforts to limit pay of the wealthiest gained traction in the 1930s; 'economic royalists'

ALAN BRINKLEY

POLICE, COURTS, AND LAWS---ON THE MARKET

No comments:

BLOG ARCHIVE