Romney’s Lead Economist Urges Policies That Will Cause the Next Financial Crisis
Presidential nominees of either U.S. party can secure economic advice from any economist in the world. This makes it all the more amazing and sad that they choose economists with track records of disastrous policy advice. Bill Clinton chose Robert Rubin, George W. Bush chose Gregory Mankiw. Obama chose Lawrence Summers. And Mitt Romney has chosen Greg Mankiw. Rubin and Summers led the Clinton administration’s efforts to gut financial regulation, while Mankiw led the efforts under Bush. Collectively, these efforts created the criminogenic environment that produced widespread financial fraud (also known as “green slime”).
I have often emphasized the importance of George Akerlof and Paul Romer’s 1993 article (“Looting: the Economic Underworld of Bankruptcy for Profit”) to understand the economics of why we suffer epidemics of accounting control fraud and recurrent, intensifying financial crises. Mankiw was the “discussant” when Akerlof and Romer formally presented that paper. I was also present at their invitation, and I can report that Mankiw was unconcerned about the issue of looting in the discussion of the Savings and Loan crisis. It was my first introduction to Mankiw's stated morality: “It would be irrational for savings and loans [CEOs] not to loot.” I was appalled, but my outrage at Mankiw paled when I observed that the members of the audience -- professional economists -- were not even made visibly uncomfortable by such a depraved response to elite fraud. CEOs owe fiduciary duties to the shareholders, and Mankiw’s response to the findings that CEOs were looting their shareholders was to praise the rationality of the fraudulent CEOs. If you don’t loot you, you’re insane. One cannot compete with "theoclassical" economists’ unintentional self-parody.
Mankiw and "Green Slime"
Recently, Mankiw wrote a column in the New York Times praising competition among governments, which is a good place to analyze his faulty philosophy. I start with an historical note that falsifies Mankiw’s claim that competition among governments is desirable. Mankiw supports his claim by noting that the “founding fathers were no fools.” In an odd way, we can thank our immensely successful Constitution for avoiding the demonstrated disaster produced by governmental competition engendered by the Articles of Confederation. The States competed vigorously – to aid their merchants at the expense of “foreign” States (their neighboring States). They competed to impose more destructive internal tariffs (and other trade barriers) so aggressively that they crippled commerce. This is one of the principal defects that led the committee appointed to reform the Articles to instead junk them and adopt our Constitution. The upshot was that the Constitution created a nation instead of a confederation. The interstate commerce and supremacy clauses were key provisions of the new Constitution because the framers knew that competition among the States and the new federal government could threaten our nation’s survival.
In the context of public finance and financial regulation, Mankiw’s praise for such competition demonstrates that he has learned nothing useful from our recurrent crises. Competition among governments in financial regulation leads to the criminogenic financial deregulation that produces the epidemics of green slime that drive our financial crises. I have recently explained, in the context of opposing the JOBS Act, why the “regulatory race to the bottom” is an oxymoron designed by regular morons.
Mankiw read Akerlof and Romer 19 years ago, but he missed what they were saying, even though they ended their article with this paragraph in order to emphasize their key policy message:
“Neither the public nor economists foresaw that [S&L deregulation was] bound to produce looting. Nor, unaware of the concept, could they have known how serious it would be. Thus the regulators in the field who understood what was happening from the beginning found lukewarm support, at best, for their cause. Now we know better. If we learn from experience, history need not repeat itself” (George Akerlof & Paul Romer.1993: 60).
Competition among governments in the financial deregulation context leads to a devastating “race to the bottom” which is “bound to produce looting.” An economist should have no difficulty understanding this point, for classical economists stressed hundreds of years ago that the government’s central function is to prevent crime of force and fraud. Even Ayn Rand called for the government to prevent fraud. As Akerlof and Romer stressed, accounting fraud produces a “sure thing” because creditors do not exercise effective “private market discipline” against such frauds. Instead, they rush to fund the frauds’ rapid growth.
Worse, as executive and professional compensation has become far larger and more perverse, creditors and purchasers can grow wealthy by adopting a “don’t ask; don’t tell” policy designed to ignore even endemic fraud. Charles Calomiris, who is as culpable as any economist for spreading financial deregulatory dogma globally, suggests that the perpetrators may have deliberately created “plausible deniability":
“Asset managers were placing someone else’s money at risk, and earning huge salaries, bonuses and management fees for being willing to pretend that these were reasonable investments. [T]hey may have reasoned that other competi[tors] were behaving similarly, and that they would be able to blame the collapse (when it inevitably came) on an unexpected shock.”
In combination, deregulation and perverse compensation are so criminogenic that they can produce green slime in such massive amounts that it dominates massive aspects of finance.
Mankiw tries to dress up the question of whether governments should compete as a philosophical dispute about the proper role of government. That is incorrect in the financial regulatory context. The regulators have to serve as the “cops on the beat” – and economics has emphasized for centuries the essential need for the government to provide such a rule of law and limit fraud and violence.
We know objectively that Mankiw, Bush, and Romney do not actually favor competition in financial regulation – for none of them opposed the OCC and OTS’ scorched earth campaign to preempt state efforts to regulate predatory lending and seek to reduce mortgage fraud. The states attempted to offer a competitive alternative to Mankiw, Greenspan, Bernake, and Bush’s indifference to fraud by elites. That competition could have led to vastly better outcomes for the citizens of the states that wished to be most vigorous against fraud and the nation. Mankiw was Chairman of Bush’s Council of Economic Advisors during the worst excesses of the federal agencies efforts to prevent the states from regulating entities (e.g., bank holding company affiliates not subject to federal regulation) that spread the green slime through the financial system. He did not oppose preemption. Mankiw and his political patrons do not favor competition in financial regulation – they favor regulation so weak that it will be ineffective. They hate financial regulations that are successful because such regulations challenge their world view that denigrates democratic government and government regulators.
Romney’s choice of Mankiw, one of the leading architects of and apologists for the crisis, as his leading economic advisor would be a superb issue for Obama to use in his reelection campaign but for one tiny problem. The Obama administration’s policies on financial regulation are created by the likes of Rubin, Summers, Geithner, and Bernanke. They differ only on the margins from Mankiw. The entire crew of leading economists for the last three presidents and Romney has proven catastrophically wrong about financial regulation. The remarkable thing is that they do not drop their dogmas even after they engineer multiple crises over the course of three decades. We will soon experience the 30th anniversary of the Garn-St Germain Act of 1982, which set off a renewed “competition in laxity” among the states (principally California and Texas; whose S&Ls, collectively, caused roughly two-thirds of all S&L losses) and produced the criminogenic environment that led to the second phase of the S&L debacle.
There are economists and scholars from other fields that have track records of success as financial regulators. Note to Obama and Romney: there is no rule requiring you to choose as your leading advisors the purveyors of green slime and crisis. A significant number of Mankiw’s students walked out of his class to protest his presentation of failed dogma in the guise of economics. It is time for all of us as citizens to walk out on politicians who choose ethical and economics failures like Mankiw and Geithner as their advisors.