The ideological significance of the financial crisis

The financial crisis is nearing its three year anniversary, and the ideologically-tinged battles over identifying its causes are still roaring on. For champions of the free market, much is at stake in explaining what led to the 2008 financial meltdown. On its face, it appears that banks and investors foolishly jumped on the bandwagon of an asset bubble driven by the extension of easy credit. When that bubble popped, the investment vehicles built on top of it saw a huge loss in value, causing a panic that would have — if not for government intervention — precipitated a world-wide financial collapse and great depression.

Investors and banks incompetently bankrupting themselves and bringing down the rest of the world with them is hard to reconcile with the usual rhetoric about the self-correcting, rational, efficient market. Defenders of that particular ideology are then pressed to find some way to explain away the crisis that absolves the market actors from the colossal mistakes that they made. If they can blame their actions on something else — ideally government behavior — then they can protect their free market ideology from what would otherwise be a devastating counter-example to its practicality.

Efforts to provide a government-blaming explanation have revolved around two main claims. The first is that the Community Reinvestment Act — a 1977 law that outlaws the racist practice of redlining — forced banks to make the bad mortgages that drove the asset bubble and the eventual financial collapse. At first glance, this argument is very implausible given that the law has been around for three decades, and only requires community banks not to discriminate between equally creditworthy individuals. Whatever one thought of the viability of the argument, it was crushed in the Financial Crisis Inquiry Commission report which found the following:

The Commission concludes the CRA [Community Reinvestment Act] was not a signifcant factor in subprime lending or the crisis. Many subprime lenders were not subject to the CRA. Research indicates only 6% of high-cost loans — a proxy for subprime loans — had any connection to the law. Loans made by CRA-regulated lenders in the neighborhoods in which they were required to lend were half as likely to default as similar loans made in the same neighborhoods by independent mortgage originators not subject to the law.

With that attempt to blame the government defeated, the only other argument coming from those trying to defend the market ideology centers around Fannie and Freddie. The arguments surrounding that are fairly technical and largely depend on disputes about definitions. I wont go into the discussion in depth here, but Mark Thoma provides an abundance of different analyses explaining where those arguments go wrong. The short of it is this: even though Fannie and Freddie did foolishly participate in subprime lending and securitization, they were late to the game and were only responding to existing market trends set by private originators and investment houses.

To that analysis, I would add that even if the behavior of Fannie and Freddie did lead banks and investors to create a speculative bubble, there is no reason it should have. Private market actors were under no obligation to buy mortgage-backed securities; ratings agencies were under no obligation to provide AAA ratings to those securities; investment firms were under no obligation to leverage themselves in a way that left them insolvent when the bubble burst; AIG was under no obligation to insure the mortgage-backed securities in a way that would eventually leave the firm bankrupt; and, other mortgage originators and investment banks were under no obligation to copy the practices of Fannie and Freddie (although we know that Fannie and Freddie were actually copying their bad practices).

The fact that market actors freely chose to do all of these things reflect that they had misjudged the risk the housing bubble posed, a sector-wide misjudgment that had catastrophic consequences for the entire world. Defenders of the ideology of unrestrained markets have nothing that they can say about those freely chosen decisions. Market actors are supposed to be acting on all of the knowledge that is available to them, including any distortions that Fannie and Freddie introduce, information about which was public and accessible. They are not supposed to make decisions which bankrupt their own firms and bring down the entire financial sector, certainly not en masse. But in this case, they did exactly that.

What the financial crisis represents is a real-world refutation of the idea that the market is rational and can be counted upon to self-regulate. In theory that argument has some compelling features. After all, why would a firm trying to maximize profits take actions which destroys itself. Whatever the reason is — incompetence, misplaced incentives, or irrational exuberance — we have a perfect example of firms doing just that.

If proponents of a wide-open free market were intellectually honest about this financial crisis, they would have to revise their views in the same way that Alan Greenspan — previously a proponent of the ideology of self-regulating markets — did soon after the meltdown took place. Of course, just because they should do it does not mean that they will. Given the central importance of this view for the entire ideology of the right wing, I am doubtful anything could ever convince them to abandon it.

Ways to think about government distribution policy

With the debt ceiling theatre nearly reaching its climax, remarks about spending cuts, tax increases, ending tax loopholes, and other sorts of deficit reduction approaches are being tossed out daily by politicians and political commentators. In addition to being a bit abstract, the debates surrounding these topics often devolve into a muddled mess. One of the primary reasons for the muddling is the confused ways that people try to understand government policy that affects economic distribution.

The chief confusion is centered around what we consider the baseline to be when making comparisons of different government distribution policies. With America’s strong laissez-faire tradition, it is common for individuals to take a roughly laissez-faire policy to be the baseline against which comparisons are made. Using a laissez-faire baseline, increasing taxes to fund programs for the poor is a form of redistrbution. Under the same baseline, decreasing taxes and cutting programs for the poor is not a form of redistribution; rather, it is a rectification of previous redistribution.

This logic also holds for tax loopholes and tax deductions. For better clarity, consider the mortgage interest deduction. Under this program, home owners are able to deduct from their income taxes the amount they pay in interest on their mortgage. If we consider the amount of income taxes paid at the established marginal rates to be the baseline, then the mortgage interest deduction is a form of targeted government spending. It is functionally indistinguishable from sending a check to homeowners for the amount of their mortgage interest. In the context of a marginal-rates baseline, targeted deductions are a way the government spends through the tax code.

Under a laissez-faire baseline, tax loopholes and tax deductions are not considered targeted government spending; instead, they are considered ways of rolling back — in a very narrow way — previous deviations from the laissez-faire norm. This is how conservative commentators are able to suggest that closing tax loopholes which permit corporations to pay far fewer taxes than the established marginal rates allow is a tax increase. Against a laissez-faire baseline, it is a tax increase because anything above no taxes is a tax increase. Against the aforementioned marginal-rates baseline, closing a tax loophole is not a tax increase; it is the elimination of a targeted government spending program.

It is clear then how confused this discussion can get. Depending upon your baseline, the very way that you understand and describe what a particular government action is changes dramatically. Although I mentioned two possible baselines above — the marginal-rates baseline and the laissez-faire baseline — there are dozens of other possible baselines as well. In an egalitarian framework, equal distribution of economic products would be considered the baseline, and anything which causes deviations from that would be considered a form of redistribution. Under a Rawlsian framework, a distribution of economic products which maximizes the minimum available to everyone would be the baseline, deviations from which would be redistribution.

None of these baselines can reasonably be considered a neutral default. The only group who might try to argue that their baseline is a neutral default would be the proponents of laissez-faire distribution policies. Within the political culture of the United States, that might be a safe bet rhetorically, but it is not a sound position. Laissez-faire distribution policies are just that: distribution policies. Proponents of a laissez-faire baseline like to think of their baseline as being what occurs without government intervention. But in fact, laissez-faire distributions are just as much a consequence of intentional public policy as any other distribution.

There are a whole set of government policies that are put in place to generate what we call laissez-faire economies. Municipalities create land title systems which establish a singular authority on who owns what land. They create property laws which permit individuals to exclusively control and own a piece of nature, while forbidding others from making any claim on that piece of nature. They build police forces to ensure compliance with those property laws. They create courts to enforce contract compliance. The list can go on and on. All of these actions are intentional policies set up to promote a particular lassiez-faire distribution.

Now laissez-faire proponents certainly have arguments they can make in favor of these policies. They might argue that they reflect certain narrow conceptions of property rights which they favor as the correct ones. They might also argue that laissez-faire distributions reflect merit. But in making those points, they are still arguing for the government to adopt and implement intentional public policies to generate an economic distribution that they favor. It is not a default, non-interventionist distribution; it is dependent on government policies just like any other approach.

No baseline should reasonably be considered a neutral default. They all require intentional public policy to realize. So it is not possible to suggest that tax deductions and tax loopholes are really government spending or that they are really lower taxes. From some baselines it is the former; from others, it is the latter. Although it might seem that we need a baseline to describe government actions, that’s not true. In fact, using baselines is precisely what causes the confusion inherent in divergent descriptions of the exact same government action.

The logical reality is that every set of government distribution policies is redistributive and unjust from the perspective of every other set of government distribution policies. Talking about one set while adopting the framework assumptions of another is always going to yield the conclusion that the set being discussed is wrong. Using baselines based on assumptions of certain frameworks is ideologically loaded from the very start which is precisely why those baselines yield such diverging understandings of identical government policies.

The real point of contention then should not be on what we name a particular government action since the names we use are already dependent upon ideas about what distribution policies the government ought to be pursuing. Instead, in a more honest debate, the discussion should simply be about what kinds of distribution policies the government should pursue and why it should do so. In that kind of debate — unchained from framework-specific naming disputes — there are many ways to think about government distribution policy.

Individuals can argue for a laissez-faire distribution policy if they are swayed by arguments for a certain narrow conception of property rights and merit. Individuals can argue for a distribution policy based on John Rawls’ Difference Principle if they think impartiality is central to economic justice issues. They can even argue for distribution policies which maximize a certain set of human capabilities in the population if they are impressed by the capability approach to economic justice championed by Amartya Sen and Martha Nussbaum. The list of course goes on.

What is important though is to understand that these are all different ways to begin thinking about government distribution policy, not ways to deviate from the default baseline (which does not exist). So long as political commentators continue to rely on unstated baselines in their analyses, they will never be able to avoid the pitfalls of that approach. This more expanded way to think about government distribution policy offers a way to turn the debate back into the substantive realm and to avoid the frustrations inherent in the existing approaches.

What Madison had in common with Marx

Today is the 235th anniversary of the American Declaration of Independence. In the political sphere, the Fourth of July is usually a time for trumpeting the perceived greatness of America. Those more nationalistically inclined take the opportunity to repeat various facets of the standard American Exceptionalist line.

Whenever the booming proclamations of American perfection are made, my thoughts always tend to wander into the various criticisms of the rosy picture of America’s founding. Despite the praise that is poured onto this era – especially of late by the Tea Party – most people would certainly be horrified if they were suddenly dropped into the time period of the founding. After all, the founders sought to and did construct a society in which every person was excluded from equal treatment except wealthy white men.

What interests me about the intentional inequality of the system put in place by the revolutionaries is the arguments that were used to support it. There is a fundamental tension that has to be resolved between the liberal ideology that was claimed to motivate the founders and the government they actually installed. Liberalism’s promise of equality and freedom for all is clearly inconsistent with inequality – and even enslavement – for most.

To somehow make this contradiction work, arguments had to be offered to explain the exclusion. For women, the argument of the era was that they were inferior – mentally, physically, and otherwise – to men. For people of color, the argument was the same, but more severe: not only were they inferior, they were not even full persons.

For poor white men however, the argument had to be different. Appealing to inherent inferiority is inadequate to justify the unequal treatment of poor white men since they share the same inherent qualities as wealthy white men. If they are not inherently inferior to wealthy white men, then on what basis can they be excluded from equal rights (e.g. the equal right to participate in the sovereign through voting)?

There were, as with most things, multiple arguments given for this exclusion. Two arose in this period that interest me. First, James Madison famously argued that government “ought to be so constituted as to protect the minority of the opulent against the majority.” Denying the vote to poor white men, Madison claimed, is necessary because if they had a vote, the government of the country would surely be directed away from the protection of property. The liberal imperative to protect individual property is then practically in conflict with the liberal imperative of equality, and clearly the former trumps the latter for Madison.

The second argument comes from Immanuel Kant who of course is not a founder of America, but a liberal philosopher writing in the era. Kant argued that in order to vote, an individual must be a citizen, a term which he clearly defines in Theory and Practice:

The only qualification required by a citizen (apart, of course, from being an adult male) is that he must be his own master, and must have some property (which can include any skill, trade, fine art or science) to support himself. In cases where he must earn his living from others, he must earn it only by selling that which is his, and not by allowing others to make use of him; for he must in the true sense of the word serve no-one but the commonwealth.

What is interesting about the arguments from both Kant and Madison is how closely they line up with the basic anti-capitalist arguments that pop up later in the writings of communists, socialists, and anarchists, most famously Marx. The idea from Madison that if the working people were truly able to express themselves politically they would tear down the present slate of property arrangements could be ripped right out of The Communist Manifesto.

The idea from Kant that wage workers (which is the class of people he excludes from citizenship) are not truly their own masters, but are dependent on and controlled by those who they work for, is a classic argument in favor of socialism. The supporters of socialism argue that only when workers own the workplace they labor in will they truly be their own masters.

Although Madison and Kant did not have in mind the same remedies as the anti-capitalists did, they did seem to agree on the same description of the state of affairs. Their response to what they saw as the lack of independence and the antagonistic position of poor white men was to disenfranchise them. The response of the anti-capitalist philosophers was to empower them.