September 25, 2008

Choosing Between Rule of Law and Rule of Men

[A slightly shorter version appeared in the Denver Rocky Mountain News, Oct. 16.]

The current mortgage crisis gives us much to ponder. Many see it as part of the continuing historical debate between free-market vs. regulatory systems. And it certainly is. But there's also one undeniable lesson to be learned here regardless of which side of that debate one happens to be on:

This is not a case of just a few bad apples. The entire U.S. investment banking system is corrupted.

To review, we now know all the major investment banks over-leveraged themselves. They bundled and resold mortgages countless times, gambling that even if borrowers defaulted, repossessed properties would, on average, have accrued in value and could thus be resold at a profit. They issued risky loans, often using sub-prime, i.e., adjustable-rate mortgages for first-time homeowners with little chance of being able to pay off the debt when the interest rates increased.

Banks and brokers aggressively issued and traded these loans, knowing full well the real estate bubble would eventually burst. That's plainly irresponsible and shows a deep lack of ethics across the entire industry. It's a sobering realization that should give us pause about the culture of gamesmanship that has become normal on Wall Street.

We can and should discuss solutions, and I certainly hope the Democratic majority in Congress insists on the U.S. Treasury owning that devalued real estate behind much of the bailout. It represents about 20 million mortgages. If we're going to socialize the cost here, we should at the very least ensure that American taxpayers aren't simply reimbursing the bankers while letting them keep the property.

The AIG plan seems like the right one here, since the U.S. Treasury now owns controlling stake in the bank, and might actually turn a profit on its investment. A similar solution should be put in place for the broader bailout scheme. And if the foreign banks want a piece of the action, they can sell their equity to the U.S. Treasury. Those foundering mortgages were sold and resold at the banks' own risk. So if taxpayers are going to take on this debt themselves, they need to have stake in the real estate itself, lest they be holding nothing but paper if the mortgages deflate any further.

Following Warren Buffett's lead of purchasing bargain-basement preferred stock in faltering banks is a step in the right direction. But that's still no guarantee that the stock won't drop down even more. If Buffett wants to gamble with his own cash holdings, that's his right. But the U.S. government should have something more tangible to show for its investment.

Furthermore, there's no reason why it can't just start with, say, 1/3 of the 700 billion, and see what the market does from there. Others might just follow Buffett's lead and shore up the rest. But McCain's idea of incentivizing banks to buy it all by merely ensuring the loans, is irresponsible since it would set an artificial price for the government to have to repay if values continue to plummet.

To me, what's perhaps most interesting about all this is that the flimsy blank-check solution the White House proposes—and rushed at the last minute before the congressional recess—betrays a deep bias toward oligarchy, i.e., rule of the wealthy few. Conservative New York Times columnist David Brooks uses this very term in his first column this week (George Will makes a similar point). Brooks says the proposal is basically what economist Arnold Kling called "progressive corporatism." A system "in which government acts to create a stable—and often oligarchic—framework for capitalist endeavor."


In this brave new world, citizens no longer control any equity whatsoever. They, and their government, are taxed entirely at the pleasure of corporate dictates.

What kind of thinking makes this scenario plausible and even laudable? It seems to be a belief, prominent among Republicans, in near-absolute executive authority. We see it in President Bush and Vice President Cheney's view of their own executive privilege to flout legislation or even the constitution itself whenever it suits them. We see it in Sarah Palin's notion that she is prepared for the presidency because of her "executive experience." As if being a Mayor or Governor is akin to being a Monarch. To them, the Geneva Convention against torture is nothing but a quaint and naïve rule of etiquette.

They really believe in the naked power of individuals to do whatever they deem necessary to get the job done. And that's because they see the swashbuckling drive of the American Dream as the fuel of capitalism and all that ever gets accomplished. This allows them to trust in that drive, forgetting that its power must often be checked for the greater good.

And that's what the laws of our liberal democracy are for. But as Aristotle warned us over 2000 years ago, oligarchs will always seek to replace the rule of law with the rule of men. It's crucial once again that we not let them.