Monday, December 22, 2008

Creating Wealth, or Stealing It?

Today's first hour of "On Point" (from WBUR, Boston) discussed the value of the services provided to the economy by the people who sold the mortgage securities which led to the current economic collapse. The people who invented these securities were not alone or isolated. In the environment provided to them, they followed the scent of money to a jackpot. Greed, craven indifference to consequences, and ideological dogmatism opposed to regulation, all played roles in the eventual debacle. But, in search of a new system to prevent another such dire economic failure, these are not traits that can be regulated. What general principles can be extracted from this experience to guide us in creating a new environment, in which the scent of money cannot be followed down a trail to fraud?

Free market people talk about the market being "self-correcting", but people behave individualistically. It may be that "the market" has a self-interest (the maximum benefit for the maximum number) in stability and sustainability, but individuals will do what they can get away with to capture what wealth they can. Free market theorists, like Mr. Greenspan, have failed to note the distinction between the interests and behavior of "the market" (an aggregate behavior conducted in an economic commons) and that of individuals (whose opportunistic advantage may be both fleeting and intoxicating), and were reportedly "stunned" when a deregulated market did not penalize brokers and bankers who were gorging at the trough of cash coming from investors. They were blindsided by the obvious.

The rule, for example, is that when you go to the market, you pay for your pork roast. Generally, a customer would go home with it and prepare to cook it. If then she discovered it was sub-standard, she would return it to the seller, who will make her whole for the sake of his reputation and his business, and because the law says he must. The law, of course, says he is entitled to be paid for the roast, and the customer is entitled to healthy food. Without such laws, the arrangement that brought the pork roast to the neighborhood grocer would collapse.

In the case of the mortgage security meltdown, if the seller notices that you never look at your roast, and discovers you are taking these roasts and selling them by the truck load to people that never look at them, the seller might think he can sell you rotten meat, a sack of potatoes, anything he can get his hands on, and in fact for awhile, he, you, and lots of other people will make plenty of money transferring worthless product to someone who seems not to care, or is trusting you. But sooner or later those trucks will begin to stink, and people will open the truck doors and discover how much rotten crap is really in there. Somehow, someone had slipped the bonds of accountability in this transaction for long enough to defraud many people out of much money.

If any law was being broken, no one noticed, nor did anyone have a reason to notice. Everyone was getting rich. But even if no law said this could not be done, some people were deprived of the benefit of their money, while others got the benefit of that money for a fraudulent product. The limits, the incentives, of the market aligned to perpetuate a fraud. "The market" did not correct itself. "Why," we might ask, "without strict definition of allowable behavior, would we expect individual self-interest to align with the interests of the commons? Why would 'the market' self correct?"

If we know we must regulate, how and when do we do so, and what do we want to achieve?

As the last caller said, "If a guy like Bill Gates can make billions creating a whole new industry, fine," but what have the securities wizards of Wall Street given us? On a continuum, businesses range from those that create wealth, to those that concentrate and extract wealth, perhaps even steal it, without adding any value to the community at large. We can ask "Does this business increase the overall wealth and quality of life of its community, or does it impoverish its community?"

Explicitly criminal enterprises either extract wealth (extortion, "protection") or thrive by selling a product (drugs) with short term "benefits" to its clients who, however, damage the community by engaging in overtly damaging extraction - theft, mugging, extortion. Ponzi schemes are illegal, because they cannot fulfill their promises. Some other sometimes not legal enterprises (Casinos) are devoted to wealth accumulation at the expense of their customers, but are sometimes legal because the customer is (theoretically) aware of the dangers. Some Wall street enterprises (mortgage securities) extracted wealth from investors, but their product or the act of creating it was not illegal because we had not awoken to their inner contradictions. "Network marketing" looks a lot like a Ponzi scheme, and has in the past been tightly regulated, even though they do in fact sell products. Pay-day lenders are being carefully scrutinized because of the uncertain balance of values. Banks, because they handle money, have in the past been tightly regulated, because the use of that money can add or subtract value from the community of which it is a part. Other service businesses, like lawyers and plumbers, require a license, to guarantee the quality of the work, but are free to charge what they want to, and spend their money anyway they want to. Other businesses sell or make products, and the public interest resides in the healthfulness of those products, and the effects of its production on the natural environment and the workers who produce them, but they are free to sell goods, hire people, borrow, build, buy, invest or liquidate, because we understand the business to be about creating new wealth, about producing goods or services that are in demand in the community and beneficial to the health of the community. The values of the community align with the values of the individual.

In all of these examples, the great schism is between activity which improves the quality of life and activity which damages the quality of life. The salient question when looking at any economic activity is first "Is this a method of creating new wealth? Or a method of concentrating other people's wealth?" And second "Does this activity contribute to the general prosperity, or reduce it?" While related, they are not the same question.

The failure of the market and of the government was to foresee that the Wall Street securities brokers would strike out on both counts, in fact fail to even ask the questions. Any business devoted to concentrating wealth without providing an obvious public benefit deserves to be regulated *per se*, and any time a new product or enterprise is to be introduced, we have a right to ask how that product or enterprise fares on those questions. Certainly, NO NEW SECURITY PRODUCT should ever be legal at all until after it has been scrutinized by dispassionate, non-ideological regulators.

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