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
Richard Primus raprimus at umich.edu
K. Sabeel Rahmansabeel.rahman at brooklaw.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
What are we to make of Bob Ivry, Bradley Keoun and Phil Kuntz's blockbuster report on the Fed's bailouts? The three journalists conclude that "taxpayers paid a price beyond dollars as the secret funding helped preserve a broken status quo and enabled the biggest banks to grow even bigger." Yves Smith argues that "banks lied" and grabbed $13 billion in profit. She also notes that their favorite water carrier, Timothy Geithner, "told Congressmen they were too stupid to be able to shrink banks, and they should leave those questions to the Basel Committee (which has no interest in making big banks smaller)."
For another perspective on the corrupt relationship between megabanks and our central bank, consider John Kay's recent description of the "martingale" strategy among bettors:
Each time you lose, you increase your stake: to the point at which a win on the next game would recoup all your losses and leave you ahead. Since you will win sooner or later, you are certain to come home with a small profit. Provided you are infinitely rich before you start. Otherwise, if you regularly engage in martingales, you will eventually go bankrupt – and the richer you are, the larger the scale of bankruptcy.
Since anyone who studies the problem knows that ruin is the outcome, your bank, or your bookmaker, will probably call a halt to the game while the shirt remains on your back. Such capitulation will leave you with a large loss, and an enduring grievance that others have deprived you of a great coup.
As financial instability continues, we can count on a few things. Some will lose, and some gain, a great deal. Troubled companies are going to gamble on resurrection. As long as they have an infinite backstop from a central bank, they may well succeed. Peter Boone and Simon Johnson describe how a “doomsday cycle” of privatized gains and socialized losses continues to this day:
[M]ajor private sector firms (banks and nonbank financial institutions) have a distorted incentive structure that encourages eventually costly risk-taking. Unfortunately, the measures taken in various US and European bailout rounds during 2008-2009 (and again in 2010 for the eurozone) have only worsened, and extended to far more entities, these underlying moral hazard incentive problems. . . .
This cycle of boom followed by bailouts and bust amounts to a form of implicit taxpayer subsidy that encourages individual institutions to become larger – and the system as a whole to swell. Our preparation to bail out their creditors means systemic institutions are able to raise finance cheaply in global markets. The implicit subsidy to creditors encourages greater debt, which makes the system ever more precarious.
As various economists contest the value of the financial sector, the critical role of "too big to fail" (TBTF) status needs to be front-and-center. Paul Krugman recently concluded that the economic crisis "showed . . . the apparent value created by modern finance was a mirage." I would say that it was not the crisis, but the response, that confirmed this. A system that socializes losses, but privatizes gains, is not free enterprise. As Dean Baker observed of the bailout of A.I.G. in particular, the policy "ensure[s] that [financial institutions] suffer no consequences from their mistake[s]."
As I noted back in the summer, 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. Abandoned homes and crumbling roads and bridges are the rubble left by the martingales of a self-aggrandizing elite. They would rather see mass homelessness than suffer a tiny financial transactions tax that could address that problem (and many others).
A final note: I'm not saying here "fiat justitia, ruat caelum." A lender of last resort must, on occasion, lend as a last resort. All I am saying is that it is deeply troubling for anyone to reconcile themselves to the Fed's (and the Treasury's) vast emergency powers without simultaneously demanding that those powers are used to sharply limit the pay and prerogatives of those at TBTF institutions, and to help ameliorate the economic devastation they've caused.