The Hopeful Science
The Libertarian and the Lobbyists
Simon Johnson
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WASHINGTON, DC – In the three years since the global financial crisis erupted, two dominant views of what went wrong have emerged. It is crucial that we understand each, because their implications for policymakers – and thus for the future health and stability of the global economy – could not be greater.
The first view is that governments simply lost control of the situation, either through incompetence or because politicians were pursuing their own agendas. This is the view heard most frequently from the political right – for example, from people who think that the main problem in the run-up to the financial meltdown of 2008 was government housing policies.
In the United States, among the candidates still competing for the Republican Party’s nomination to challenge Barack Obama in November’s presidential election, Ron Paul stands out for arguing consistently that government is the problem, not the answer, with regard to banking. If the government were removed more fully from the financial sector (including abolishing the Federal Reserve), he argues, the economy would function better.
The second view is that the financial sector lobbied long and hard for deregulation in recent decades, and spent a great deal of time and money persuading politicians that it constituted the safe and modern approach to banking. According to this view, government policies did not fail; on the contrary, they operated exactly as intended – and as bought and paid for.
If this view is correct, the kind of policy prescription recommended by Ron Paul is less appealing. Unless you think that a modern financial sector really can operate with absolutely no regulation of any kind (including, presumably, the rules for banks that come with deposit insurance), the real problem is not government officials’ policy preferences, but what financial-sector lobbyists are able to persuade officials to do.
Fresh evidence supporting the second view is now available in the form of a recent study by Deniz Igan and Prachi Mishra of the International Monetary Fund. In “Three’s Company: Wall Street, Capitol Hill, and K Street,” the authors look at the data – lots of it – on lobbying by financial-sector companies in the US.
Legislators, of course, have different preferences about what kinds of laws to support, which can make it hard to study mechanisms of political influence precisely. But Igan and Mishra approach the problem in a clever way – they look for instances when elected officials switched their position on legislative proposals that surfaced more than once. And they devote a lot of effort to figuring out what caused this switch.
In addition to analyzing information about lobbying expenditures, the authors map out the network connections of lobbyists (known collectively as “K Street,” because so many have their Washington offices there) and legislators. For example, lobbyists were often previously employed by legislators on their staffs.
The results are simply staggering – although surely not a surprise to professional lobbyists. A big increase in lobbying expenditures helps to persuade legislators to switch their votes. And “whether any of the lobbyists working on a bill also worked for a legislator in the past sways the stance on that bill in favor of deregulation.”
It is deregulation, of course, that financial firms want – fewer rules and less oversight of any kind. And it really is all about whom you know, and how you know them. In particular, your value as a lobbyist seems to depend very highly on whom you worked with in the past. Igan and Mishra find “spending an extra dollar is almost twice as effective in switching a legislator’s position if the lobbyist is connected to the legislator compared to the case where the lobbyist is unconnected.”
The revolving door between Congress and lobbying firms appears to have been central to how the financial sector became deregulated, which effectively allowed excessive risk-taking in the run-up to the crisis. In another paper, Igan and Mishra, working with Thierry Tressel, found that firms taking more risks before 2008 were also engaged in more lobbying.
Essentially, financial firms have been buying the right to take on more risk. When things go well, executives in these firms get the upside – mostly in terms of immediate compensation, because few executives are compensated on the basis of risk-adjusted returns. That means that when the risks materialize and the firms suffer losses, the costs fall on taxpayers.
Ron Paul is right to point to imbalances of power and massive distortions within the financial sector. He is also correct that many government policies favor relatively few big firms – and favor them in a way that encourages excessive and dangerous risk-taking.
But Paul and others are wrong to argue that the government is the ultimate cause of all financial evil. Executives in financial firms want to take big risks. They like arrangements under which they win even when they lose.
Big financial firms can more readily buy the necessary political protection (in the form of deregulation), enabling them to become even bigger and more dangerous. This incentive structure has only become more extreme since the financial crisis of 2008.
Simon Johnson, a former chief economist of the IMF, is co-founder of a leading economics blog, http://BaselineScenario.com, a professor at MIT Sloan, a senior fellow at the Peterson Institute for International Economics, and co-author, with James Kwak, of 13 Bankers.
Copyright: Project Syndicate, 2012.
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themostalive 02:05 24 Jan 12
I think its a bit more complicated (obviously) than being able to link what happened in the recent financial crisis' with 'small' government intervention and policy, like what Ron Paul is advocating.
It was the government intervention of making cheap home loans available that led to the reckless and greedy decisions made by the large financial institutions that led to this mess.
It was not a new found sense of freedom from government regulation that led to the current catastrophe but the knowledge of the big firms that they could take massive risks with other people's money and not suffer the full consequences if that risk failed in the way of government bailouts.
If the financial sector was completely separate from the government (eliminating the option of receiving a bailout if things go pair shaped), would they be willing to be so reckless with their risk taking?
Also in regards to linking the federal reserve to Ron Paul's small government policy is also wrong and needs to be viewed as two seperate matters. The fact is, unlike other national government reserves i.e. The Reserve bank of Australia, the American Federal Reserve is still privately owned by the likes of Rothschilds et al. and operates under the guise of being a government entity. This is the one area of the financial sector that needs to be overhauled and brought into government control...
bernardpalmer 01:59 24 Jan 12
Who ever is in charge of the fiat money printing presses calls the tune. The US government is definitely to blame for the mess that is USA 2012.
Ron Paul wants to bring back gold as money thereby nobbling the bribery industry known colloquially as lobbying.
Actually it looks like lobbying and nobbling are the same thing. "Try to influence or thwart (someone or something) by underhanded or unfair methods:"
Althandir 02:15 24 Jan 12
Simon Johnson gets it right again.
Advocates of the Ron Paul position are for the most part right if they also include as a caveat a return to Full Reserve Banking. Deregulation with a fiat monetary system where the currency has no link whatsoever to anything of intrisic value has led to the disastrous consequences we continue to reel from.
For the most part, Financial Institutions in favour of abandoning government regulation are being intensely disingenous and hypocritical. These days, there is no such thing as a free market. A crude example; I cannot stand on a street corner or outside a station and sell a portion of stock I own to a passer by for a price both parties find agreeable. This crisis was caused by an interlinked shadow banking system loaded with tens of trillions of dollars of risk which was completely outside the purvue of any regulation whatsoever.
The fact is, financial institutions are in favour of regulation when it suits them. Goldman Sachs and Morgan Stanley changed their banking status almost immediately after the crisis so they could be protected by government legislation if things turned bad. For the most part, the people in charge of these organisations are incapable of hollistic thought of any kind. We all need to be protected from their immeasureable ignorance.
reddog 10:14 24 Jan 12
The “Conspiracy of Common Concept” has a more far reaching effect than mere de-regulation.
Those horse thieves who advocate for elimination of laws against stealing horses also claim Marshall Dillon is overpaid.
When the dust has settled, we find we must rebuild the fundamental structures of Democracy from the ground up.
Zsolt 10:33 23 Jan 12
Unfortunately we have long forgotten what money and banking was intended for.
Financial systems were supposed to help the exchange of goods so instead of going to the market with my chicken to buy a pair of shoe with it I can get some monetary equivalent of my chicken and then use it to buy what I need.
Then came the disconnection from resource based interactions and in order to fuel the ever increasing appetite for profit, growth and consumption we entered credit based finances and started building bubble after bubble, consuming and producing way above our necessities and capabilities.
Today places like Wall Street, the City of London and others and the interaction through them are completely disconnected from normal reality, from the normal comfortable need of people in general, only caring about increasing the number of zeros of the bank accounts of a small minority, at the same time playing with other people's money like in a casino, exactly matching our over excessive, self fulfilling and finally self destructing lifestyle and attitude to each other.
In the process the previously democratic political administration has been bought knowingly or unknowingly by the different lobby groups, today the American election campaign is a huge business, according to figures this year's campaign will cost in the region of 6 billion dollars.
It is clear from the global crisis that this system, this kind of financial attitude and economical model cannot function, cannot be sustained any more. The only question is how big of a shock, a crisis we have to go through to start looking for meaningful alternative solutions, mainly returning to necessity and resource based production and consumtpion.