Political Fatal Conceit
- From: jose el fontanero <josefsoplar@xxxxxxxxx>
- Date: Thu, 22 Apr 2010 09:14:36 -0700 (PDT)
Political Fatal Conceit
By Monty Pelerin
Economists and lawyers think differently. Economists believe that
incentives are more effective to alter behavior; lawyers believe that
coercion via laws is the way to affect behavior.
The parable of the Sun and the Wind is illustrative. They are both
intent on getting a man to remove his overcoat. The Wind tries to blow
the coat off, an action which only produces behavior that makes
retention of the coat more valuable. The Sun heats up, making removal
of the coat more comfortable than retention. In the latter case, the
man willingly removes his coat.
In the parable, the Sun behaved like an economist providing incentives
to alter behavior, while the Wind behaved like a lawyer trying to
In Washington, most elected politicians are lawyers. Too many believe
that they can achieve desired behavior via coercion. They distrust
incentives and markets. All problems are seen as having legislative
solutions -- i.e., coercions or controls. Our current financial mess
is being approached in such a fashion.
There is no real reform underway for the banking system. If real
reform were intended, the following bank expansion, as reported on
from the NY Times, would not have been permitted and encouraged:
In the last year and a half, the largest financial institutions have
only grown bigger, mainly as a result of government-brokered mergers.
They now enjoy borrowing at significantly lower rates than their
smaller competitors, a result of the bond markets' implicit assumption
that the giant banks are "too big to fail."
Instead of worrying about the real problem, the administration and
Congress took the populist route of demagogy, attacking the executives
and their pay levels. While many believe that those attacks were not
unwarranted, they were political diversions and not constructive to
producing any solution.
Size matters! The moral hazard associated with too-big-to-fail enables
large banks to engage in more risky behavior than prudent. Because of
the implied government "put" to save them, investors and depositors
provide funds in excess of what they otherwise would. The normal
corrective forces of the free market are negated by such a "put,"
enabling big banks to engage in bad behavior.
When George Schultz was Treasury Secretary and was approached with the
"too-big-to-fail" issue, he is reputed to have responded, "Well, then,
make them smaller." That was the right advice then and now. However,
according to the Times,
.... there is no attempt to break up big banks as a means of creating a
less risky financial system. Treasury Department and Federal Reserve
officials have rejected calls for doing so, saying bank size alone is
not the most important threat.
Gary H. Stern, former president of the Minneapolis Federal Reserve
Bank and co-author of Too Big to Fail: The Hazards of Bank Bailouts,
described the current bill as follows: "It tries to address the
problem but it's half a loaf at best. It doesn't address the
incentives that gave rise to the problems in the first place."
The belief that Washington is able to design any legislation for any
purpose would be laughable if it were not so harmful. Can anyone point
to a single government program that has been successful in terms of
its original intent and costs? Is there anything that has ever been
Any bill that passes without breaking up the large banks is doomed to
failure. It will ensure a repeat of this crisis, except on a larger
scale. Past interventions created the conditions for this banking
crisis. The impossibility of effective regulation enabled it to fester
Congress now proposes more of the same. Apparently, they don't
understand the definition of insanity as attributed to Einstein:
"doing the same thing over and over again and expecting different
results." Or perhaps they do and are arrogant enough to believe that
they can legislate anything, including legislating away the law of
The issue is not bad regulations, bad regulators, or bad bankers. The
issue is complexity. No one person or group is capable of writing
effective legislation for complex markets. No legislation can replace
market monitoring and discipline. That would be true even if
regulators were not influenced by politicians (the "public choice"
To believe otherwise is to engage in what Friedrich Hayek termed the
"fatal conceit." According to Greg Ransom, who made this observation
almost a year ago:
The interpretation of Barack Obama and his government as an
instantiation of what Friedrich Hayek examined in his classic book The
Fatal Conceit has become one of the dominant narratives of today. In
May John Stossel wrote a widely circulated pieceon the topic. This
week, Thomas Sowell weighs in. So does Sheldon Richman. And also Ralph
Reiland. I'm guessing we'll be hearing more about this over the next
month and year.
The only way to solve the financial crisis is to allow markets to
discipline bad banks. Effective reform of the banking system can be
achieved in only two ways:
•1. Break up the too-big-to-fail banks and preclude their attaining
the size where that adjective would ever apply again.
•2. Revisit the entire concept of banking to move it closer to free-
Both solutions would be amenable to bank failures without bailouts.
The threat of real failure reintroduces market discipline to banking.
It provides an incentive for bankers not to take the additional risks
that increase the probability of failure. Nothing being talked about
in Washington today achieves that goal.
A financial bill will pass. It will be accompanied by all the
celebratory hoopla that infects Washington. It will not break up the
big banks. It will be another Washington charade designed for the
rubes that are expected to vote in the next election. This kick-the-
can behavior is what got us into the mess, and it guarantees an even
bigger crisis in the future.
Eventually, the crisis will repeat itself. It is probable that the
next crisis will produce a worldwide collapse of the banking system.
At that point, item number 2 above, the real solution, will be
When that point is reached, we will have come full circle back to the
old Jefferson-Hamilton debates about banking. Hopefully, Jefferson
will then be seen as correct, and the world can get a banking system
that serves the people rather than the bankers. Properly designed,
banking will no longer be the cause of periodic business and financial
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