Chainsaws and Controls

Regulation of Wall Street is a topic nearly certain to get both liberals and conservatives fired up. In Tuesday’s reading, Krugman mockingly referred to a photo-op of Bush administration officials taking clippers and chainsaws to Wall Street regulations. Krugman warns about the consequences of deregulation and, more importantly for him, the absence of regulation for many financial institutions in the first place. But reading this reminded me of an Economist article that I read last month about excessive regulation of Wall Street. The article, “Law and Disorder,” expresses concern that lawsuits and fines from regulatory agencies in all directions are bombarding banks. How is it that, simultaneously, some see Wall Street as an uncontrolled monster while others view it as chained to the ground?

The answer to this question is most likely that regulating complex financial institutions requires complex language and a complex bureaucracy to interpret and enforce that language. The regulatory structure of Wall Street, as Krugman argues, needs to constantly evolve with the structure of financial institutions themselves. Otherwise, a shadow system is able to operate (quite dangerously) outside of established rules. The regulations that guide the behavior on Wall Street may seem hefty, but that is to be expected with the development of an increasingly complex financial system.

But the Economist article raises an important point about who enforces these numerous, complex regulations. It produces a long list of regulatory agencies responsible for overseeing the activities of American financial firms. In many cases, the author argues, these agencies duplicate punitive action. This not only leads to a wasteful allocation of resources, but also a disorderly regulatory structure. If responsibility for overseeing a certain activity is spread among numerous disconnected offices, the accountability of each of those offices is likely to diminish.

Steps should be taken to enhance interagency communication and to develop more effective means of cooperation. In addition, the regulatory system should be examined holistically to determine where gaps exist and where duplicity of functions is wasting resources. But overall, I agree with Krugman that Wall Street is a complex machine demanding extensive and adaptable parameters. The notion that financial institutions should be allowed to operate outside the purview of regulation neglects to consider the integral role that these institutions play in the overall health of the economy. They have the ability to send the economy into a tailspin and thus, regulation is necessary to ensure that they are not taking on excessive risk or engaging in other precarious actions. 

For Economist article, see:

http://www.economist.com/blogs/charlemagne/2012/11/reforming-french-economy?fsrc=scn/tw/te/bl/arudeawakening

Book Review: The Great Crash of 1929

Simplicity is unexpected of economists, who are often engrossed in describing the role of each potential variable through complex regressions. John Kenneth Galbraith is the exception. In The Great Crash of 1929, Galbraith, a Harvard economist, provides a captivating and straightforward account of the 1929 stock market crash. Writing in 1954, he recounts the economic disaster from development of the stock market bubble to resulting panic and collapse. His admonishing tone warns of the disastrous consequences of buying stocks based on projected price upsurges. This practice, known as speculation, is the primary perpetrator of the 1929 economic collapse according to the author. Galbraith’s narrative provides a clear and compelling warning against over-speculation, but his staunchness in highlighting one principal cause of market failure limits the comprehensiveness of his work.

Traditional views hold that the stock market merely reflects economic strength or weakness, but Galbraith identifies Wall Street as the primary cause of the Great Depression. The first chapters of The Great Crash detail 1920s optimism. According to Galbraith, Americans of the era generally hoped to acquire wealth without having to work. Escalating ticker prices satisfied their desires. Borrowing heavily to purchase stocks on margin seemed sensible, as nearly all observers predicted continuously rising prices. The only difficulty was determining which shares could most rapidly deliver affluence. Galbraith’s narrative is an incrimination of Wall Street culture and mindsets. These fueled the essential ingredients of over-speculation: unbounded greed and optimism.

For Galbraith, this over-speculation served as the principal cause of the 1929 economic downturn. Taking a significant step in contesting a popular contemporary theory, he dismisses charges that the Federal Reserve facilitated the bubble through inflationary policy. The availability of “cheap money,” according to Galbraith, does not create speculation independently, as speculation does not occur during every period of low interest rates. Galbraith suggests that even a drastic interest rate escalation would have failed to deter speculation. The exorbitant returns to speculative trading in the late 1920s would have continued regardless of interest rate increases. According to Galbraith, however, the Fed should have increased margin requirements, a direct check on the risks associated with speculative trading. Further, he argues that the Board should have spoken out against speculative trading. Instead, it remained silent. For Galbraith, the Board’s failure to actively limit over-speculation was its worst mistake.

           

The delusion that fueled the bubble persisted despite signs of economic weakness. Industrial production peaked four months before the crash. Businessmen and investors continued to express optimism even as disaster loomed on the horizon. They quickly dismissed skeptics in their ranks, refusing to credit warnings that counteracted their desires. This fueled a further divergence between stock prices and real values of companies they represented. With characteristic condescension, Galbraith writes, “Between human beings there is a type of intercourse which proceeds not from knowledge, or even from lack of knowledge, but from failure to know what isn’t known,” (75). Encouraged by those in powerful positions in business, finance and government, investors at all levels bought into the speculative frenzy, utterly unaware that inflated prices could and would ultimately collapse.

            

The decline in prices that took hold in late October validated the claims of the disparaged skeptics. Initially, bankers attempted to contain the collapse. Through “organized support,” financial leaders stepped in and purchased shares of falling stocks above current bids. This strategy briefly succeeded in thwarting the crash and sending prices upward, yet ultimately, the reality of overvaluation induced an “overwhelming, pathological desire to sell,” (110). Once investors realized that neither bankers nor government would act to prevent the crash, all illusions of order ended.  Prices plummeted and panicked selling ensued. The bubble had finally collapsed.

            

According to Galbraith, government failed to provide support necessary to mitigate this decline. Although Hoover cut taxes, adopting an appropriate Keynesian response to an impending recession, he spent the majority of his efforts attempting to restore confidence through what Galbraith portrays as frivolous meetings. The 1932 election brought only the temporary repudiation of Hoover’s laissez-faire policies. New Deal policies subjected financial markets to new regulations, but from Galbraith’s perspective, the attitude that Wall Street required substantial regulatory oversight had largely disappeared by the end of the 1930s.

            

Galbraith sets aside his final chapter to discuss the causes of the “Great Crash.” All preceding chapters clearly pinpoint wild speculation as the central cause. The sources of this speculation are less clear. Galbraith finds that the combination of an optimistic mood with accumulation of savings most directly led to speculative trading. The optimistic mood convinced potential investors that prices would continue to rise indefinitely. With accumulated savings, individuals placed lower marginal value on the money that they held. Consequently, the potential gains of speculative trading presented an attractive option for those with excess funds.

            

Even Galbraith hesitantly admits that the stock market crash did not independently cause the Great Depression. He also blames income inequality, business leveraging, a banking system susceptible to runs, international lending and trade, and a determination in Washington to endorse the contractionary aim of balancing the budget. Galbraith contends that although each of these factors weakened the economy and helped facilitate the depression, the speculative boom served as the primary catalyst. He writes, “When a greenhouse succumbs to a rainstorm, something more than a purely passive role is normally attributed to the storm,” (188). Galbraith clearly succeeds in forcefully highlighting the storm’s role, but he leaves the task of assessing the greenhouse’s weaknesses to others.

While Galbraith’s book is a forceful reminder of the deceptive and dangerous nature of speculative trading, it is far from an all-inclusive analysis of the various contributors to the Great Depression. In focusing so heavily on the role of speculation, Galbraith neglects to give adequate attention to other factors that led to the economic downturn. While he attempts to preemptively free himself from criticism of oversimplification through acknowledging other economic variables that contributed to the depression, this occurs only briefly and superficially. His title deceptively implies a more complete assessment of the entire event. In order to satisfy that purpose, he would have needed to provide more in-depth consideration to the international context, among other factors. Ultimately, however, Galbraith’s account is a clear reflection of his disappointment with Wall Street culture, and his clarity could only be achieved through downplaying other factors that contributed to economic decline. He achieves his intended aim of calling attention to the previously underrated role of speculation in the Great Crash, sending future generations a convincing warning against “the faith of Americans in quick, effortless enrichment in the stock market,” (7).

The Importance of Labor Standards

In our recent discussion about Wolf’s chapter on trade, we discussed the merits of encouraging higher labor standards abroad. Wolf and his supporters contend that, while nice for Westerners to think about, these higher standards represent inefficiency and cause a loss of desperately desired factory jobs in developing countries. But this raises an important question: does the fact that someone is willing to work under certain conditions mean that those conditions are inherently justified? My position is no.

It is unsurprising that, facing desperate poverty, men, women, and children in developing countries are willing (and possibly even happy) to accept factory jobs, despite the poor conditions and low wages relative to Western standards. However, there are two important caveats to consider in this situation. First of all, it is unlikely that workers know exactly how dangerous a workplace is until it is too late. Last month, I wrote a blog post about a September fire at a Pakistani clothing factory. The fire killed more than three hundred workers, who had trapped in a building that lacked adequate emergency exits. The danger that this building posed, both in the state of its mechanical features and its lack of safety features, would not have been easily apparent to the workers who entered its doors each day. These are costs associated with sweatshop employment that only increased labor standards and inspections (which, by the way, can be demanded by those annoying trade unions that Wolf despises).

Further, even if we assume that workers have perfect information regarding the safety of their workplaces, should we accept that they are willing to risk their own lives in order to earn factory wages? The willingness of those facing desperate poverty to take incredible risks in order to provide for their families should not be open to exploitation by multinational corporations. When society establishes safety laws, we often declare that even if individuals do not value their own safety, we will prohibit them from taking undue risks. This is the case with seatbelt laws, for example. It is also the logic behind many of the health and safety regulations currently in place in the United States, in which individuals are prohibited from working under unsafe conditions even if they think the risk is worthwhile. If American lives are not worth risking for profit, then neither are the lives of workers in developing countries.

As Wolf highlights, there are certainly costs to enhanced safety and health regulations. It is likely that companies will be able to higher fewer workers in order to comply with such regulations. It is also likely that these companies would be able to find individuals to work despite unsafe and harmful conditions. These, however, are not sufficient justifications for placing workers in dangerous, potentially life-threatening situations. 

Corporate Speech after Citizens United

The Citizens United decision in 2010 ushered in a new era of campaign spending. The 2012 election has served as the first real test of what the decision means for American politics. Essentially, Citizens United protected corporate speech (and speech on the part of labor unions) under First Amendment provisions. This freed corporations to use unlimited funds to promote candidates.

This New York Times article focuses on a new trend. This year, major companies are sending letters to employees recommending how they should vote. They are warning about the costs of electing particular candidates and suggesting, in some cases, that voting one way will endanger the future of their company. Getting a letter from your boss can be a persuasive reason to act. It might even convince you to vote for someone. 

This is a dangerous precedent. Certainly, unions are also granted the lifted restrictions that accompany Citizens United. But, in an age of declining unionization, it is not surprising that organized labor has remained unable to keep up with corporate spending.

This raises important questions for the influence of corporations in our democracy. Wolf (most clearly in the chapter on corporations that we read weeks ago) easily dismisses those who criticize the power of corporations, saying that corporations simply provide what people want. But in the case of election spending, in which corporations are attempting to influence votes, those corporations are actively interfering in democracy. Through their economic power, they can significantly affect the path that the country takes, and this is a factor for which Wolf fails to account.

For the article, see:

http://www.nytimes.com/2012/10/27/us/politics/bosses-offering-timely-advice-how-to-vote.html?pagewanted=1&_r=0&partner=rssnyt&emc=rss