William K. Black
Roger Erickson brought to my attention a column by Matthew Yglesias that relates to the ethical issues I was discussing in my column yesterday about Yglesias’ ode to GHB (Geithner, Holder, and Breuer’s doctrine of immunity for the largest banks). (In deference to Yves’ endocrinologist, I am renaming it GBH (Brit-speak for “grievous bodily harm”).
One of my criticisms was that Yglesias makes no explicit moral inquiries about the appropriateness of the administration’s GBH doctrine, which allows the fraudulent systemically dangerous institutions (SDIs) to inflict grievous harm on us with impunity. Yglesias, instead, framed the issue as an empirical and logical issue – in the context of the Great Recession, would our financial system be better off if we held banksters and fraudulent banks accountable for their crimes or if we bailed them out? Yglesias’ position is that if the decision is made that our financial system would be better off if we bailed the banks out (a position he supports), then it follows as a matter of simple logic that we must not prosecute. Indeed, Yglesias opined that bailing out the banks so obviously excluded prosecuting elite frauds that anyone who thought differently was “nuts.”
“But either way, implementing a non-nationalization approach to bank recapitalization and then prosecuting the banks into a renewed state of insolvency and then nationalizing them would have been nuts. If saving the banks was a mistake, then the error had nothing in particular to do with prosecutions, and if saving the banks was the right thing to do, then curtailing prosecutions was the only way to execute the strategy.”
“Mankiw Morality” is the term I coined to describe the mindset of theoclassical economists who think that wealth maximization is either inherently moral or transcends morality because it is “rational.” N. Gregory Mankiw was the discussant on George Akerlof and Paul Romer’s famous 1993 paper – “Looting: the Economic Underworld of Bankruptcy for Profit.” Akerlof and Romer were discussing accounting control fraud. Akerlof and Romer’s message that elites caused enormous economic damage by using their control over seemingly legitimate firms to become wealthy by “looting” “their” bank was, of course, anathema to Mankiw. Mankiw is a leading defender of businesses and opponent of regulation and the defender of the faith in theoclassical dogmas. Two passages from Akerlof and Romer illustrate the revolutionary nature of the challenge that control fraud poses to theoclassical economics. First, they used the “f” word (fraud) – violating the most powerful and primal of the tribal taboos of the economists’ clan. In this passage, they used an even more powerful four-letter word (“loot”), signifying the betrayal of the fiduciary duties of care and loyalty by the CEO.
“[M]any economists still seem not to understand that a combination of circumstances in the 1980s made it very easy to loot a financial institution with little risk of prosecution. Once this is clear, it becomes obvious that high-risk strategies that would pay off only in some states of the world were only for the timid. Why abuse the system to pursue a gamble that might pay off when you can exploit a sure thing with little risk of prosecution?” (Akerlof & Romer 1993: 4-5).
From Mankiw’s perspective, Akerlof & Romer then compounded their blasphemy by explaining that the widespread looting was not aberrant – it was the product of perverse incentives created as a result of the “unintended consequences” of deregulation. The Wagnerian leitmotif of the theoclassical economists’ clan is a variant on the theme of unintended consequences (always in the minor chord) of governmental programs intended to help the poor or the environment. Akerlof and Romer’s article was a brutal contrapuntal refutation of Mankiw’s main motif.
“Neither the public nor economists foresaw that [S&L deregulation was] bound to produce looting. Nor, unaware of the concept, could they have known how serious it would be. Thus the regulators in the field who understood what was happening from the beginning found lukewarm support, at best, for their cause. Now we know better. If we learn from experience, history need not repeat itself.”
Akerlof and Romer were explaining that it was the deregulators, not the regulators, who created a terrible unintended consequence – widespread accounting control fraud that had caused what was then the worst financial scandal in our history, the S&L debacle. The most elite private sector CEOs – those who ran our financial institutions were the criminals. The heroes were the field regulators “who understood what was happening from the beginning.” It is difficult to describe how subversive that phrase is to a theoclassical economist like Mankiw. The failures in Akerlof and Romer’s tale are conventional economists like Mankiw, so the paragraph was doubly insulting from his perspective. The most distressing lines were the concluding sentences – the two sentences that Akerlof and Romer chose to end their article in order to emphasize their policy message. The key fact that we now “know better” was that deregulation was “bound to produce looting” because it created such perverse incentives and crippled the regulatory cop on the beat who was essential to detect, prevent, and sanction elite frauds and prevent the Gresham’s dynamic that Akerlof had made famous in his seminal article on control frauds by seemingly legitimate sellers who use deceit to disguise the bad quality of their goods or services.
“[D]ishonest dealings tend to drive honest dealings out of the market. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence” George Akerlof (1970) (discussing a market for “lemons”).
Mankiw’s response to the Akerlof and Romer featured his dismissal of the ethics of fraud by elite bankers: “it would be irrational for savings and loans [CEOs] not to loot.” If the CEO has an incentive to loot (which he nearly always does) then he is “irrational” (not “moral”) if he refuses to loot. Mankiw Morality is, of course, an oxymoron that describes those who strip moral decisions of their moral component.
One does not expect ethical insights from a theoclassical economist like Mankiw, but Yglesias received at least initial training in ethics as part of his formal education. His post-secondary education consists of an undergraduate degree in philosophy. Yglesias’ adoption of Mankiw Morality will make his professors cringe. The Yglesias column that Roger Erickson alerted me to shows that Yglesias is familiar with Frederic Bastiat’s work.
Why I Don’t Love Frederic Bastiat. By Matthew Yglesias (Aug. 18, 2012)
I agree with Yglesias’ column on Bastiat, but there is a famous quotation by Bastiat, not mentioned in that Yglesias’ column, that warns about Mankiw Morality.
“When plunder becomes a way of life for a group of men living together in society, they create for themselves in the course of time a legal system that authorizes it and a moral code that glorifies it (Frederic Bastiat).”
The GBH doctrine, which Yglesias’ has endorsed in two columns, represents a legal system that now “authorizes” “plunder” and a “moral [free] code that glorifies it.” The SDIs’ CEOs became our rock stars during the bubble. Goldman Sach’s CEO, Lloyd Blankfein, famously claimed that the banks were “doing God’s work.” Yglesias may wish to read Bastiat about crony capitalism and examine (I wish I could say “reexamine”) the ethical issues inherent in the GBH doctrine. Declaring that our most elite banksters – the people who caused the financial crisis and became wealthy through their looting – should be exempt from the rule of law is I believe the most destructive public policy we could follow in the finance context. It is Yglesias’ indifference to injustice that causes me to call him out for his embrace of Mankiw Morality. We have an architect of torture teaching at Boalt Hall and Mankiw at Harvard, so Yglesias is small beer.