an unanticipated consequence of
Jack M. Balkin
Jack Balkin: jackbalkin at yahoo.com
Bruce Ackerman bruce.ackerman at yale.edu
Ian Ayres ian.ayres at yale.edu
Mary Dudziak mary.l.dudziak at emory.edu
Joey Fishkin joey.fishkin at gmail.com
Heather Gerken heather.gerken at yale.edu
Abbe Gluck abbe.gluck at yale.edu
Mark Graber mgraber at law.umaryland.edu
Stephen Griffin sgriffin at tulane.edu
Bernard Harcourt harcourt at uchicago.edu
Scott Horton shorto at law.columbia.edu
Andrew Koppelman akoppelman at law.northwestern.edu
Marty Lederman msl46 at law.georgetown.edu
Sanford Levinson slevinson at law.utexas.edu
David Luban david.luban at gmail.com
Gerard Magliocca gmaglioc at iupui.edu
Jason Mazzone mazzonej at illinois.edu
Linda McClain lmcclain at bu.edu
John Mikhail mikhail at law.georgetown.edu
Frank Pasquale pasquale.frank at gmail.com
Nate Persily npersily at gmail.com
Michael Stokes Paulsen michaelstokespaulsen at gmail.com
Deborah Pearlstein dpearlst at princeton.edu
Rick Pildes rick.pildes at nyu.edu
Alice Ristroph alice.ristroph at shu.edu
Neil Siegel siegel at law.duke.edu
Brian Tamanaha btamanaha at wulaw.wustl.edu
Mark Tushnet mtushnet at law.harvard.edu
Adam Winkler winkler at ucla.edu
Sandy Levinson has posted interesting reflections on our tendency to "absolutize" the public debt. There is at least one good and one bad rationale for us to do so. The good rationale is straightforward: government is the ultimate risk manager. We rely on it to aid recovery after disasters, to defend US interests, and to provide for those who cannot survive using their own funds. In a world of advanced and expensive medical technology, that last category potentially includes nearly everyone, at some point in their lives. The debt ceiling debate is a wake-up call for us to choose more carefully between guns and butter. We need credit so that the government can borrow to, say, rebuild a city after a massive earthquake.
But there is also a bad reason for the rising stakes of US spending. To put it bluntly, the too-big-to-fail banks are the new Fannie Mae and Freddie Mac. The government must "keep its powder dry" in constant vigilance, ready to "re-TARP" the damage should any panic befall them. Consider, for instance, the current agonies of the Eurozone, as described by John Lanchester:
[Greek protesters] want the Greek government to default, and the banks to accept losses for loans they shouldn’t have made in the first place. It is that prospect which spooks everyone else in the EU, and the world economic order generally. . . . Who owns that Greek debt? [M]ainly French and German banks. Yes, but banks insure their debt via the use of complex financial instruments. Insure it with whom? Don’t know: some of it is insured with British banks as counter-parties to the risk, but that risk will be insured in its turn, so that the identity of the person holding the parcel when its last layer of wrapping comes off is a mystery. That mysteriousness was the thing that made Lehman’s collapse turn instantly into a systemic crisis.
Lanchester is right to compare the Greek debt crisis to Lehman. Both are important because of the network of bets that surround "credit events." Both were enabled by fancy financial footwork to hide debts. The US government is presently engaged in similar maneuvers. Just as it claimed not to back Fannie and Freddie (to move their potential liabilities off its balance sheet), it now repeatedly insists that it won't bail out Goldman, Citi, etc. And just as surely as it stepped up to the plate once "Freddie" faltered, costing American taxpayers close to $150 billion, it will step in to save the counterparties of the TBTFs. Here's Pulitzer-prize-winning financial journalist Jesse Eisinger on the phenomenon:
Another way taxpayers coddle the biggest banks is by implicitly guaranteeing their derivatives business. . . . "No sensible person would put a nickel on deposit in the normal course given the enormity and opacity of the derivatives portfolios," said Amar Bhidé, a former trader and business professor at the Fletcher School. "It's entirely a function of deposit insurance and the implicit guarantee that the JPMorgan counterparties have."
The government's actions in the financial crisis only cemented that certainty. Counterparties and investors that were previously not guaranteed, like holders of money market funds, were protected at every turn. This bailout never ended. "In effect, we nationalized the biggest banks years ago," Mr. Allison said. "We implicitly guaranteed them. The taxpayers are still the ultimate owners of the risk in those banks -- they just don't get equity returns for that ownership."
Rather, those returns go to the top traders, and the occasional politicos and ex-regulators who smooth their way through Beltway politics. As Steve Randy Waldman has argued, a bank like Goldman Sachs stands in the same relation to the federal government as the “variable interest entities” (VIEs), special purpose vehicles, and conduits set up by Citibank before the crisis stood in relation to Citibank. Those entities were “off balance sheet” legally, but everyone knew that Citibank would ultimately support them.
Shockingly, nearly three years after the Sept. 2008 meltdown, we still have a financial order where regulators can barely monitor (let alone limit) the scope and size of the bets of these too-big-to-fail entities. Moreover, as Lanchester explains, "markets" are so powerful that European authorities are afraid even to disclose if they have a plan to deal with default:
Argentina defaulted in 2002, froze the banks, declared its foreign debts void, and cut itself off from IMF funding – and since then, it’s been the fastest-growing economy in fast-growing South America. . . . But this is an extremely high-risk strategy, not just for Greece but for the whole of Europe, and to attempt it would require that a lot of planning had already taken place. But we wouldn’t know if it had, because these plans need to be kept secret in advance if markets aren’t to bet on exploiting them. If this work hasn’t happened, extensively and at levels which carry the necessary political clout to execute the plans when the default happens, the euro is odds-on to fail.
In the past week or so, President Obama has mystified and alienated progressives with his insistence on "going big" on a debt deal, finding four trillion dollars to cut. The "going big" strategy doesn't make much sense when we could solve the deficit problem by doing nothing. But for a President as unwilling to challenge Wall Street as Obama is, it makes perfect sense. The US must choose between guns, butter, and continuing to support the gambling that keeps too-big-to-fail banks flush. Many of those who made great fortunes from that gambling are bankrolling an anti-revenue movement that pledges never to allow their taxes to rise. The guns are called essential due to arms races, terror threats, and humanitarian missions, real and imagined. The butter is on the chopping block.