Economics, Literature and Scepticism

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I am a PhD student in Economics. I am originally from South Africa and plan to return there after my PhD. I completed my M. Comm in Economics and my MA In Creative Writing (Poetry) at the University of Cape Town, where I worked as a lecturer before starting my PhD.

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Thursday, September 25, 2008

Who doesn't pay?

Posted by Simon Halliday | Thursday, September 25, 2008 | Category: |

I have not written at all about the financial crisis that is going on, predominantly in the US, but now also in 'the world'.  My 2 cents is going to be focused on what I would call the philosophical problems of the Paulson Plan.  My reasoning for this has to do with the idea of desert and related concepts of responsibility and accountability.  The eventual outcome of my argument will be that the Paulson Plan does not hold those who were responsible for the outcomes accountable for their actions and actually penalizes those who weren't responsible.  Obviously there are political economy reasons for this, but that's not what this post is about.

So, let me take a couple of views on responsibility and accountability.

First Thomas Scanlon (1988, 176):
[W]hat is required for moral appraisal on the view I am presenting is the freedom, whatever it may be, which is required by critically reflective, rational self-governance. But this is less appropriately thought of as a kind of freedom than as a kind of intrapersonal responsiveness. What is required is that what we do  be importantly dependent on our process of critical reflection, that that process itself be sensitive to reasons, and that later stages of the process be importantly dependent on conclusions reached at earlier stages. But there is no reason, as far as I can see, to require that this process itself not be a causal product of antecedent events and conditions.
And then John Roemer
[T]o hold a person accountable for an action will mean that he should pay for it - he should, perhaps, compensate others who were harmed by the action, or be penalized by society for it. (Roemer, 1998, 17)
And Richard Arneson (2000, 12) elaborates usefully,
[O]ne is responsible for a choice (that affects only oneself) when one is allowed to absorb its costs and benefits for oneself without compensation.
Now Paulson, in his plan, says that we should not 'constrain CEO compensation' during streams of retrenchments that could feasibly occur as a consequence of the current crisis.  [Aside: Paulson is an ex-CEO of Goldman Sachs and is worth several hundred million dollars himself.]

Many of the CEOs involved in those companies which have fallen during the current crisis are directly responsible and accountable for the actions that have occurred.  They championed policies that led to the use of risky assets and the selling of mortgages to risky individuals - they are responsible.  However, Paulson is arguing that we should not hold them at all accountable (As Paul Krugman comments, "Demands for complete discretion with zero accountability").  As a consequence of their actions taxpayers in the US will have to pay at least 700bn USD (that's billion, not million as some have misreported, comment here).  Moreover, thousands will have lost jobs, money and houses as a consequence of actions and policies adopted by CEOs on Wall Street.  Consider an individual who had saved money, worked hard and was in permanent employment at the low end of one of these firms, did not take part in any of the risky business, but has lost investments (hopefully not their home), their job and now has to pay, possibly in perpetuity, through taxes to BAIL OUT those whose actions resulted in him losing his money, losing his job and having to pay more taxes.

On top of this, Paulson does not want limits on CEO pay packets, for them to be able to walk away with 'golden parachutes' to be rewarded more money by the boys club of CEOs even though they are the ones who should lose money, lose their jobs and be held accountable for their actions by the public and by government for the riskiness of their actions. He basically wants a blank cheque.  I am not even going to go into the Moral Hazard aspect of what this does for incentives.

So, what the plan does is to capitulate to the wants of those who don't want to be held responsible.  It banks on the fact that the individuals who are so greatly affected on 'main street' want something to help them and therefore allow those responsible not to be held accountable because of the depth of their own suffering.  Allez the CEO boys club! Allez!

I am with Mark Thoma when he says:
Peoples' lives are nothing to be toyed with, and if a bailout is the only way to avoid the chance of massive meltdown and widespread job loss, so be it. Protect Main Street first and foremost, but give away as little as possible to Wall Street in the process.
However, none of the above takes into consideration the extent to which individuals will pay taxes as a a consequence of these bailouts. I agree with David Colander when he says that “What matters is what price they buy the assets for and the price they sell them for. That’s where the real action is.” Why is this the real centre of the problem? Well, depending on how much the US Treasury Pays (and therefore how much taxpayers have to pay over the next while) the level of the risk borne by the US Treasury (and thus by taxpayers) increases or decreases.

As David Leonhart of the NYT argues:
It clearly shouldn’t pay 75 cents on the dollar, or anything close to it. That would mean the Treasury Department — which, in the end, is really you and me — was assuming nearly all the risk. But it probably can’t pay 25 cents. That might fail to fix the credit markets, because
it would do relatively little to improve financial firms’ balance sheets. Firms might then remain unwilling to lend money to businesses and households, which is the whole problem the bailout is meant to solve.
And finally, from the open letter by economists on the plan that was just sent to congress:
Its fairness. The plan is a subsidy to investors at taxpayers’ expense.
Investors who took risks to earn profits must also bear the losses. Not
every business failure carries “systemic risk.” The government can
ensure a well-functioning financial industry, able to make new loans to
creditworthy borrowers, without bailing out particular investors and
institutions whose choices proved unwise.
And as Hillary Rodham Clinton comments:
[T]axpayers are being asked to bear an unparalleled degree of
financial risk. We cannot allow taxpayers to take on this burden so
that Wall Street and the Bush administration can hit the "reset
button." This historic intervention demands a historic shift in
priorities: an end to the broken culture on Wall Street, and the broken
economic policies in Washington.
So there are two crucial things for me:
  1. CEO payouts should be limited
  2. The US Treasury and tax payers should not be bearing all the risk the CEOs and those who took the risks unnecessarily should take it, should lose their jobs and should not get additional benefits.
Hopefully that is clear enough.

Currently have 3 comments:

  1. Good post Si and I totally agree. I'm not even going to have to pay for the bailout plan via my taxes and I find it upsetting.

    I'm quite surprised in all of this that nobody seems to be discussing one of the root causes of this problem: the principal-agent problem between shareholders and managers. Federal regulations requiring shareholder democracy (with greatly improved transparency and an overhaul of how boards of directors work) would in my view help prevent future screw-ups of this kind.

    By the way: your aside about Paulson is seemingly an instance of poisoning the well. (It's not that his past is irrelevant, it's that it must be presented in the right context).

  2. I meant to post this piece on shareholder democracy before:

  3. The aside is not meant to 'poison the well', but it is intended as an indicator of the position he might be taking.

    Actually, there has been a fair amount written about PA issues, if I recall Brad DL, EconomistsView and others have commented on corporate structures. But I don't have the energy right now to search and link. lol.