Sunday, September 7, 2008

Risk is a Four-letter Word

Jon Henke describes "How the Right Loses" by outlining a vicious cycle of inciting risks by socializing them, then paying for the moral hazard they create, blaming the 'market' for Govt-induced and encouraged misbehaviors, then socializing the whole kit n kaboodle.

This is a good dissection of what has happened in a number of arenas, and not just in finance. We see that Govt gets more an more involved, via FEMA, into emergency/disaster management, to the point where the expectation is for no loss nor misery nor hardship when Nature Unleashes Its Fury. Yet with each giveaway to those suffering from floods, we get more houses build on floodplains, with each hurricane recovery funding, we get more million dollar homes on outer banks sandbars.

"the corporate welfare style typical of American government--privatize the profits, socialize the risk" this was said in the bailout of the Savings and Loans. It has merit, but the demerit here is that it's not as if shareholders getting anything but wipedout in the bailout of bankrupt companies. Who is really helped is the portfolio owners (aka 'bagholders') holding written down risky paper.

I came to this article via Pejman at RedState who observed:

And unless we find a way to break out of that dynamic, we will be left to lather, rinse and repeat the next time a similar situation rolls around.

Yes, this is a slouching towards Socialism. Some thoughts on the mindset components:

1) Step #3 - blaming the market for individual misbehaviors - is the most flawed step in the 'logic' of the process: The free-market economy is blamed, when in fact a free market means market players can choose to incur risk. Dont blame the game for the misbehavior of player. The existence of market risk is not a 'bug' in free market economics, its a feature inherent in freedom. Risk is the flipside of opportunity and the reduction of risk is good free-market behavior that comes from: Being contrarian, being diversified, having good market information, resisting the urge to believe bubble-market pie-in-the-sky.

Some blame deregulation, not noticing that deregulation allowed and allows for market based risk mitigation and has opened up so many opportunities for wealth-creation that have not been abused, and to cite it is a 'throw the baby out with the bathwater' perspective. That said, if we know there is a "risk of excess govt intervention down the road" due to market bubble, we'll have to trade off certain regulations that curtail risk-behavior to avoid more invasive regulation later. In the case of the mortgage market, it would have been so easy to have simple rules like no ARMs and no high-risk/sub-prime loans above 80% LTV, and stricter limit on actual owner-occupancy to get residential (vs commercial) loan programs. Those simple rules I suspect would have kept housing from bubbling and bursting. But it begs the question: How do we estimate risk of future Govt intervention or market blowups to decide if such market sail-trimming regs are needed?

2) the "Crisis stampede" - Just as markets have bubbles, politics has stampedes, the group-think of "Let's do it now" that gives us bad laws often. We should consider the flaw in the "Dont just stand there, regulate something" attitude of Congress towards problems we face. Govt cannot regulate away risk or failure. All it can do is redistribute the pain. The pain of mortgagee and foreclosed property owners is spread to taxpayers and the next generation.

The best thing we can do as conservatives and Republicans is make sure that we do not create permanent regulations and agencies to address a one-time event. So if there is a dramatic proposal, let it be a 5-year term (like the patriot act was done), so we can discuss 5 years later if the regulation worked or has unintended consequences.

3) Economic risk tolerance as a cultural indicator that can resist the siren call of socialism:

Socialism today exists in America largely as a result of various forms of risk-mitigation after-the-fact, but is done in a way that fails to encourage risk-avoidance. It brings with it problems of free ridership, socializing of unwarranted risk, and regulating activities best left to the market. The term often used is "moral hazard".

Socialism is not rational, but when it comes to risk, people are often irrational. The gambling industry depends on it. For example, would you rather have 100% chance of $1 million or a 20% chance of $6 million? What is 'rational' there?

Consider: Social Security and Medicare is risk-mitigation. They exist because people had a fear of what might happen to them. The whole concept of "social insurance" should be broken into 2 components - the insurance of individuals and families on behalf of themselves (which should be privatized as much as possible), and the redistribution of wealth for insurance and security of those not able to pay their own way - which should be provided to only those in need of and pay-your-bills-when you are old.

We need a culture that is more tolerant and accepting of the existence of economic risk, at least when it comes to the 85% of us who are not in poverty and in no danger of starving, etc. we need with that a market and financial system more able to weather financial bumps without a 'systemic risk' . We need an economic system with enough 'upside' of prosperity that makes taking on that additional risk worth it - to investors, workers, retirees, etc.

We need to contine to push "ownership society" and "choice" agenda items to help Americans stand on their own. When they do they will resist the calls to stick it to investors. This has to be a growth, opportunity and prosperity (GOP!) message.

4) We pander to groups 'in need' but the real beneficieries are the providers, often corporate, of that need/service. The mindset should be: Help those in hurt and in need, not those who merely have red ink this year but plenty left in the bank account. After all, I am hurting too this year. The Stock market is lower now than when Nancy pelosi and the Democrats took control of Congress. Where do I get a refund? Oh, I dont get one? So why do Wall Street types/insiders get refunds on their bad loans?

There is firm ground here: Yes to help targeted to 'those in need' but no to corporate welfare to 'those in greed'.

5) The false thinking of "Its the End of Civilization" just because one of the periodic financial crises occurs - We heard it in 1992 from Perot. I heard it in the 1980s. It keeps getting recycled. I'm reminded of it even here, with:

"Twenty years ago we were the last best hope of man. " - Really? The NYTimes had assured us back then that Reaganomics was a failure and we would be in hock to the Japanese by now. Peter Peterson assured us in Atlantic Monthly that Social Security would bust us by now. We are still the last best hope of man. You want to leave that burden to the EU, Russia or China?

"Ten years ago we were the locomotive of the world economy. " Bring back $10/barrel oil and a lot of things would look better. Yet US exports are higher than ever. In truth, we werent that good then and we are arent that bad now. America is still a strong country and a strong economy, the largest and most productive economy in the world. We shouldn't buy into false doomsday preaching.

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