Tuesday, May 22, 2012

What Kind of Regulation Do We Need?

One of the reasons I gave this blog the name it has is because many of Paul Krugman's claims seem to have originated in Wonderland, and his recent column on financial regulation proves once again that Krugman is a master of the half-truth and is more political operative than economist. He begins:
Sometimes it’s hard to explain why we need strong financial regulation — especially in an era saturated with pro-business, pro-market propaganda. So we should always be grateful when someone makes the case for regulation more compelling and easier to understand. And this week, that means offering a special shout-out to two men: Jamie Dimon and Mitt Romney.
 Given that we have a leftist president who hates capitalism (or at least capitalism that is not based upon giving him campaign contributions and requires political connections), and given that the leading media organizations tend to be anti-capitalist, I'm not sure where this "pro-business, pro-market propaganda" can be found. Nonetheless, because Krugman makes this claim, his followers will say that his very words make his point true.

Before I deal directly with Krugman's claim -- that the financial industry in the USA is unregulated, despite its too-big-to-fail status -- I would like to point out something that I believe is ironic: the hypocrisy of the screams about J.P. Morgan losing two billion dollars when the NYT and Krugman are demanding that taxpayers pony up many billions of dollars in order to prop up the politically-connected "green energy" business. As I see it, if Krugman is so wanting to prevent huge financial and business losses in the economy, then I have a perfect place for him and his cohorts to begin: pulling the plug on "green energy" subsidies.

I will let the NY Times speak for itself (and I have no doubt that Krugman is in agreement, given his earlier support for such subsidies):

The federal government has given generously to the clean energy industry over the last few years, funneling billions of dollars in grants, loans and tax breaks to renewable power sources like wind and solar, biofuels and electric vehicles. “Clean tech” has been good in return. (Indeed, since they have contributed "generously" to Obama's re-election campaign. That is the only "good" return I can surmise would be the case.)

During the recession, it was one of the few sectors to add jobs. Costs of wind turbines and solar cells have fallen over the last five years, electricity from renewables has more than doubled, construction is under way on the country’s first new nuclear power plant in decades. And the United States remains an important player in the global clean energy market.

Yet this productive relationship is in peril, mainly because federal funding is about to drop off a cliff and the Republican wrecking crew in the House remains generally hostile to programs that threaten the hegemony of the oil and gas interests. The clean energy incentives provided by President Obama’s 2009 stimulus bill are coming to an end, while other longer-standing subsidies are expiring.
If nothing changes, clean energy funding will drop from a peak of $44.3 billion in 2009 to $16 billion this year and $11 billion in 2014 — a 75 percent decline.

This alarming news is contained in a new report from experts at the Brookings Institution, the World Resources Institute and the Breakthrough Institute. It is a timely effort to attach real numbers to an increasingly politicized debate over energy subsidies.
I must admit that even someone as cynical as I is stunned by this nonsense. Here are Krugman and his employer screaming about a firm losing two billion while at the same time claiming that losses of close to $100 billion by a single industry are somehow "good" for the economy. (The NYT also commits the "Broken Window Fallacy" by claiming that the "clean energy" industry "was one of the few sectors to add jobs." The addition of these "jobs" did not add wealth, but rather destroyed it, but that little bit of logic is anathema to the likes of NYT editors and Paul Krugman.)

Nonetheless, Krugman makes a number of fallacious claims in his column, and I would like to briefly deal with them. First, he wants us to believe that "too-big-to-fail" is a natural consequence of a market system. One has to remember that in order to get to that kind of a size, a firm must outgrow external markets, and if that were to happen, then the firm would lose its ability to engage in economic calculation, something pointed out by Murray N. Rothbard in Man, Economy and State.

Firms don't do that on their own, as that same market that Krugman despises quickly would discipline the company for the inevitable economic errors it would be committing. Second, Krugman makes some heroic assumptions regarding economic and financial regulation, the most obvious being that somehow, a risk-averse regulator always or nearly always would know exactly what kind of decisions to make for the firm that is being regulated.

Instead, what we would see would be a replay of what happened over the years as the banking system set up during the New Deal evolved into a system that would fund only those established industries that also had close relationships with banking and the government. This effectively would be socialized banking without the official title of socialism, and anyone who has seen a socialist country knows a time warp that such risk-averse systems create.

Many of the things that we enjoy today came about because of entrepreneurs both in finance and in the creation of new products, and I will say unequivocally that the system that Krugman demands to be in place would not be capable of taking the kinds of risks that were necessary to create modern telecommunications, home computers, cell phones, the Internet as we know it, and numerous things that simply did not exist three decades ago and would not have existed at all had Krugman had his way.

One has to remember that nowhere in Krugman's formal economic training did he learn anything about entrepreneurship. His program at MIT was heavily into mathematical models and it is impossible to model entrepreneurship as such. Instead, the models will assume "a new technology" or some other "shock" and then the math is applied from there. 

Thus, I will contend that because Krugman is hostile to anything outside the mathematical realm, and because the Austrians are the ones that really have integrated entrepreneurship into their entire economic analysis (and Krugman already has demonstrated his utter hostility to all things Austrian), that he really is incapable of intellectually understanding entrepreneurship. Furthermore, he maintains a childlike belief in the Progressive view of economic regulation, as though all one has to do is to have enough faith in the regulators and the system they represent, and the regulators will make omniscient decisions.

It is not that the financial system does not need regulation; indeed, it does need regulation, but the kind that only the markets can apply. Instead, we get the kind of regulation that depends upon political relationships, implied bailouts, and moral hazard on steroids. 

Oh, and then people like Krugman tell us that a Really Good Deal is subsidized energy, which destroys wealth while it drains taxpayers and makes them poorer. Maybe we ought to be putting these regulatory burdens upon the Solyndras and making the banks and financial houses account for their own losses.


Mike M said...

As a side note, Krugman must be ecstatic! The economic problems in Italy are solved. They had an earthquake. Think of all the jobs and economic activity that will be generated by rebuilding. Add to that the multiplier effect and he must be positively euphoric about Italy’s prospects going forward to help lead Europe out of the abyss.

Wait…. Not working out like he thought? Well the earthquake wasn’t big enough then. More destruction, we need more destruction! Doesn’t God know that Europe needs help? He must not care about the Italians or else surly he would have rained a 9.0 down on them.

If only we had a government regulator of earthquakes, he would have got the magnitude right.

William L. Anderson said...

I love it!

Tel said...

You only need to do a google search on "foreclosure fraud scandal" to see what various banks have been up to, and see that neither Krugman's column, nor anyone in the Obama government are willing to call them out over it.

Well, to be fair, Krugman made some small effort here...


... but he misses the most important point. You can't have investor confidence and consumer confidence in a system where laws are systematically broken and the big players can very easily get away with it. It's a rigged system, and now that just about everyone understands this, nothing productive will happen until the Rule of Law is restored in such a way that ordinary folks are satisfied.

In the case of mark-to-market accounting being "temporarily suspended" years ago, Krugman is now coming out and supporting this as an excellent idea to allow banks to hide their losses and deceive the public, err I mean, it prevents "Amplification Of Financial Distress" so once more investors are supposedly going to put their money into an institution with arbitrary sized black holes sitting on the books. How stupid does he think people are?

Krugman just waves it away and says, "confidence fairy" as if that was in any way an argument. Then he says, "Very Serious Person" as if that was in any way an argument. Sure it's a big joke when institutions are systematically dishonest, but if you don't laugh at the joke, then the Joker says, "Why so serious?" and beats you up.

So yes, there is a role for government regulation, and it's a very simple role: make sure the market participants are honest, make sure contracts are upheld, and when those things don't happen, follow the law, work through the bankruptcy and clean up the mess.

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