Recently spoke with Sandra Schulte regarding the role of federal agencies in defining and regulating laws as passed by Congress.
This is Part 2 of 2.
Speaking at “Speak Up!” with Sandra Schulte – Part 1
Recently spoke with Sandra Schulte regarding the Role of federal agencies in defining and regulating Congressional laws.
This is Part 1 of 2.
DISORGANIZED CRIMES goes international…
Accounting fraud at WIRECARD.
Every so often a seemingly deliberate accounting fraud deceives investors and accountants and winds up stimulating regulatory zeal. The financials debacles of 2001-2 and 2008-9 led to Sarbanes-Oxley and Gramm-Dodd. We should expect that if the Corona-virus causes immense financial dislocations, we will see financial fraud and regulatory actions grow apace. Before the curtain on new episodes of Congressional Propriety goes up, we should begin to ask whether regulators have succeeded in the past and what costs are imposed? The recent disclosure of a large financial fraud in a large German public company (Wirecard) is a signal for the fraud parade is beginning. We don’t really have the essential facts to analyze this case but the similarity to our previous work elicits a few comments
1) Most accounting frauds of major public companies are detected by some market participants long before regulators are ever alerted. Regulators don’t like short sellers so they are often late to the crime and by then the major damage to the “longs” has been done. Next come the lawyers, but that is a story about insurance law and rewards to successful class action litigators. There are several lessons here worth remembering. One might be if E&Y, Wirecard’s auditor noticed anything from Wirecard’s price volatility much earlier? If so, why didn’t they act much earlier. The usual answer is that they don’t wish to lose a client. More on this below
- such frauds usually begin with companies already on a losing path. The resulting frauds are designed to conceal true operating losses. Enron and WorldCom are class one exhibits
- frauds of this kind usually involve auditors who have long standing ties to the fraud company. (ah, yes… should we be asking for term limits for auditors once again?). We can count on the advocacy of those most affected (accounting firms) and political friends to be assured that meaningful term limits are not likely
- another question to ask is “Where were the Directors?” But even without the facts in this case, we know that Directors are more often there to bless and shield their managements. They are not likely to probe too deeply in searching potential corporate financial behavior for mismanagement or fraud cases. Company managements get very uncomfortable with a overly-zealous Director
2) Is regulation imperfect as an answer to deter financial fraud? Again, case details are important, but generic punishments without individual liabilities for Directors, Auditors and Corporate General Counsels make ongoing investigation difficult and unrewarding to outside agencies tasked to protect investors. Conclusion: the corporate establishment that includes auditors, directors, general counsels, credit raters, underwriters, and even some bankers is all to willing to sacrifice by investing in more errors and omissions insurance and reliance on the long lag between crime and punishment in exchange for avoiding personal liability. (“You can’t blame me for dishonest clients!”)
It is another example of the famous line in the movie A Few Good Men, when Defense Counsel (Cruise) demands the truth, Colonel Jessup (Nicholson) answers, “YOU CAN’T HANDLE THE TRUTH.” We call this Jessup’s Law. It needs to be a part of every class in Corporate Governance!
In short, Frauds like Crime are inevitable because for some individuals, the probable rewards of fraud exceed the expected value of their personal losses.
Of course, we could do better, but the costs of fraud protection via regulations rise as well. We could do better, perhaps, but we infer that Society believes the optimal quantity of financial fraud is not zero. The costs of prevention are not zero, while the praise for corporate honesty from Philosophers, Pastors and Op-ed Writers is insufficient to enforce a more rigorous anti-fraud environment.
Bloomberg’s report on Wirecard can be found at https://www.bloomberg.com/news/articles/2020-06-26/wirecard-auditors-say-elaborate-fraud-led-to-missing-billions
The Evil of Two Lessers
Many Americans today are doubly distressed. First, the obvious setback to a “normal” life in a free country are the Government lockdowns to defeat COVID-19. Second, the impending November election in a very badly divided country forcing a choice between the extremist views of the two leading candidates. Both candidates exhibit seemingly less in leadership qualities than what is truly needed.
We need not dwell extensively on the rank statements of the current President and his frequent feuds with the media nor on the rather strange remarks of the likely Democratic nominee. We merely observe that either candidate is likely to heighten the distress of Americans who believe in limited but cooperative government that is nonpartisan in the best sense of the term. It goes without saying that the politics of surviving the onset of COVID-19 in a meaningful way has been hardly nonpartisan. The “helicopter money” approach so far provided is an effort largely devoted to political optics not economics. To state the obvious in a country that needs to go back to work: does it make sense to pay an unemployed worker more to stay unemployed than to have that worker gainfully and permanently employed even at a lower wage? That is what both parties agreed to under the duress of the Virus War. It is not a tribute to rational government policy. It is a device used by both parties to appear to get something done when they fail to agree on an overriding strategy.
On the other side of the coin are the efforts of the Federal Reserve to operate a monetary regime that is as much fiscal as it is monetary policy. The Fed is “applauded” by both parties but the larger term components of massive Fed intervention in the debt markets are left relatively unexplored. The most recent is the Fed’s deployment of buying privately issued loans to unrated public and private companies.1 It is at best an experiment, but it takes our central bank far beyond anything ever contemplated or truly understood as central banking policy measures.
“Do Something Now” is the ruling guidelines of American politicians of all stripes. This is an optics game not a well-engineered policy strategy with appropriate cost-benefit qualifications. It also runs the risk of saddling the country with a monumental debt overhang without necessarily providing the economics of sustainable growth to liquidate that debt. World War II aviators often spoke of flying back from their missions holding their damaged planes together with “chewing gum and baling wire.” That was a necessity.
Flailing government policy to fight the Virus War is surely not optimal policy, but when the politicians have dramatically different purposes for Government, that is what you get. One can only hope that the State does not run out of gum!
“A republic if you can keep it,” as Benjamin Franklin once said, but can we keep it in a war where the politicians do not agree what kind of government we should have?2 One side clearly believes in throwing massive amounts of money out from a vast armada of currency-laden helicopters is a solution while the other side fears that the present economy cannot recover under the set of disincentives now or likely to be established.
Next comes the Presidential and Congressional Elections. What can we expect from such a contest in which each side has assembled a set of Generals to run the war with totally divergent strategies? One is reminded of Lincoln’s three-year struggle with inadequate military leaders until Grant proved willing and able to defeat the Confederacy? Then the country had a national purpose and a leader whose unifying principle was to save the Union. Can we expect the same in November? On the basis of the evidence so far, it seems highly unlikely. Both presumed candidates have waffled on a “needed national purpose.” Both are frightened by health and medical experts whose own models of the pandemic have given and still give conflicting predictions about the course of the Virus War.
Good strategy in war begins with a defined objective and a multiplicity of tactics evaluated with common tools. It is impossible to discern the strategy of each party or its presumed candidate at this point. One observes such a variety of changing tactics that hardly any military historian would infer a high likelihood of success. STUMBLECONOMICS might be a better description of either Party’s strategy?
Like Lincoln, we are still looking for our General.
- The Main Street New Loan Facility, authorized under Section 13(3) of the Federal Reserve Act, can purchase loans in a SPV made to all kinds of businesses including corporations, partnerships, LLC’s, trusts, associations, cooperatives, and joint ventures or tribal businesses, where the initial lender is a financial intermediary that will take a minority risk interest in the loan. [↩]
- Quoted in Walter Isaacson, Benjamin Franklin: An American Life (New York: Simon & Schuster Paperbacks, 2003), 459. [↩]
Impediments to Rational Policy Choice on Covid-19
Fauci has become an impediment to rational policy choice. He is talking his book and his book was and is wrong.
The data pretty clearly show that for those under 45 (the principal cadre of industrialized country work forces) the true mortality rate is not going up nor is it hugely high. But expectations of testing and hospitalization have been pushed up way out of line with what the current state of treatment availability and success rates can do.
(I ignore developing countries with high density cities whose public resources are badly limited. That is an issue more closely aligned with underdevelopment and resource limitations of the state, both financial and physical).
Distancing and working on hotspots are a legitimate strategy which should be promoted along with a careful statement by health care and political leaders that policy has to be one of triage — treating heavily those most likely to recover. Lockdown is not a strategy that can promote recovery. Lockdown may work to save Grandma, but at whose expense? Re-opening is not heartless. It is fighting back. It is doing what we have to do to survive and prosper once again. There will be casualties, and some will die. That is what happens in war.
It is “Heartless” but not “Headless”. It is a health truth, but our Politicos lack the courage to tell the public what the current state of medical arts can do. We have a political aversion to truth that is totally bipartisan. Churchill understood that in 1940 but we have no Churchill to lead the public.
We have dealt with and can deal with the physical capacity issues of medical treatment. NYC proved that. But we are going to have death loss in the + 45 age group. Not high in % terms but a family that loses a parent or a grandparent will not be easily consoled.
Those are the facts. Until we have a viable set of treatments (forget about a quick vaccine answer this year), our major focus is recovery for those most likely to recover. In the meantime, we will have casualties and death loss. That is what triage means in war and this is a war.
Political lying only encourages bad policy.
Now, the real risk is the economic recovery. And wringing tears from Fauci are an obstacle course. They can only promote bad policy as is evident in Democratic Helicopter Money proposals today. The talking heads all criticize markets and public firms about being so short run focused on next quarter’s earnings. From what I read public firms are adapting very quickly and considering how to operate with the virus going forward.
I don’t see that same degree of adaptability and innovation in the public sector — take the Tesla Tantrum as an example or closing the Fall semester at CSU! The right public strategy is to work out a plan that allows some reopening, and not stand on ceremony! By the way non-elected permanent bureaucrats rule with as much foresight as George III once did! They are not accountable!
And adaptability and innovation are the critical strategic aptitudes of winners in war and again this is a war!
Unfortunately Trump is not a believable leader so I am at a loss as to how to get thoughtful strategy into the public arena over the crying towels of the public sobbing heads of the media or non-elected bureaucrats with fixed ideas and agenda.
The Troubling Return to Central Controls
No one ever claimed that the path to freedom was untroubled by rocks in the road, but the corona pandemic has put added potholes and big detours in freedom’s path. We need to be observant of the risks that have now been created by the massive “step-in” of Government. Perhaps, the most amazing aspect has been the willingness of so many Americans to give over their personal responsibilities and ambitions to the cabal of politicians who in recent years they had learned to distrust. This is a bi-partisan, if misguided, delusion–––by the voters. They had previously demonstrated extreme disgust with the antics in Washington (and in many State Capitols in 2016), but the virus has thrown an unexpected curve ball at that stance. Fear of the unknown is a great mobilizer for giving up one’s personal controls over the conditions of life. More problems than additional infections and deaths is the current willingness to surrender control over our lives, and this terror has not been confined to individuals. Many corporate leaders, not seeing an immediate way out of the morass that lockdowns have created, are now on a pleading platform hoping to save what is left of their companies and their own power.
Coronaviruses–––there have been more than a few–––have crippling effects precisely because developing proper pharmaceutical treatment, let alone efficacious vaccines, has been a monumental task for even the best of the “biopharmas.”1 Believers in the efficacy of Government over Markets can point to the Manhattan Project and the claims that DARPA created the Internet as evidence that a properly marshaled government can perform wonderful magic when pressed into service. But is that a question of organization or an unlimited budget, untroubled by the personal concerns of private business for an adequate return to investment capital? Surely, we should distinguish between a war mentality that pits our survival as a nation as justification for Government takeovers and what we truly face, ugly though it may be, with COVID-19? Our national survival is not at stake.
No one should ignore the deaths that the virus has caused or is likely to cause before this particularly ugly pandemic has receded. As we currently approach some 70,000 deaths in the US caused by COVID-19, we are unpleasantly reminded that an ounce of prevention is better than a pound of cure. That said, adequate preparation for rare events is not particularly a virtue that Government has demonstrated. On the contrary, Government has been caught out more frequently than not when confronted with a rapid change in geopolitics, pandemics, or rapid technological change. That is in the nature of a free state governed by modest checks and balances. There will always be new dangers and questionable responses. Freedom is not a free lunch. We pay for our freedom by allowing multiple sources of information…and the threat that is insidious is to suppress the vast amounts of information that markets provide merely by their operation. Government may be a poor example of a first responder.
There are always post event claims of the “gurudom,” voices unlistened to at an early time, but Government is always and anywhere a late starter and then an information suppressor. Risk management occurs in private business because of the necessity of a budget restraints and the claims of equity and debt holders on current earnings coupled to the limits of corporate saving. That is how it should be. Failure in corporate or personal business is a great, even if unplanned, source of innovation. Yet, innovation is the mechanism that produces a better life for our specie. We learn, often through tragic circumstances, where not to reside, which natural flora and fauna are dangerous to our health, and which devices are likely to help us when we are surrounded by dangers to our survival. We do it piecemeal, and the uphill road to knowledge and control is fraught with many setbacks. However, the human condition is built on learning and progressing diversified by our experience in many different environments. That cumulative learning curve is our human history..
In military affairs, the State is often the driver of technology change, but there too, the State stumbles and often goes down roads to dead ends. In the worst of cases, we see the State collapse when it cannot marshal sufficient technologies or manpower or bureaucratic organization to overcome its adversaries. That is an important historical marker that should caution us to rely solely on the State organization of science, technology, production, and distribution. There is simply no way centralized government planning can duplicate the massive information production and distribution that a myriad of private markets provides nor the ever-present incentives to innovate when sufficient information is available. State planning often relies on very imperfect information and then commits vast quantities of resources chasing down roads to nowhere.
While it is true that there some counterexamples to these State-generated failures, it is more often than that States bury false moves and strategies until the light of historical research finally highlights them…often generations later. Sometimes, we attribute these cover-ups as the result of poor leadership, but that is truly another kind of error. With the power to marshal State resources, most leaders that go down false paths do not willingly provide evidence of their errors and there is no market response that normally would be self-correcting when error produces loss. In the most violent examples, States that find individuals who disagree with policy or judgment calls on the direction of technology or strategy use State violence to suppress alternative interpretations of facts and policies. Stalin murdered Tukhachevsky—his erstwhile former leading general of WWI—-prior to the advent of WWII. While the US doesn’t murder dissident military leaders, it does punish those out of step leaders who want to pursue alternatives not endorsed by the current ruling military clique. Hello Billy Mitchell, and George Patton—-you have great company with Winston Churchill.
That is the nature of Government—-it severely punishes dissenters within. Furthermore, it is hard for Government to finance and nurture alternative paths under the duress of military survival—-precisely what markets do every day. Great discoveries come from mavericks who throw out conventional wisdom because their failures are personal, not societal. Government failure can be societal precisely because once we hand over markets to Government, there are few outside alternatives to the Government ”truth!”
That is where the real danger lies today. Ironically, in spite of manifold distortions of truth and information, even this much criticized Administration has created, albeit by default, some remedy to overall Government takeover. Our Federal system allows, in fact, commands, many sources of alternative information and activity. Those politicians who demand a National Policy for fighting the corona virus miss the virtue of multiple attempts by State and local leaders—-and that provides an unending stream of useful information over what works and what fails. This administration has stumbled into the virtues of multi-pronged efforts by State governments probably because of its own lack of risk management much earlier in the game. Unfortunately, the current wisdom was that Lockdown was the appropriate death-mitigation model. That may turn out to be a half-truth if we find that restarting the American economy becomes a painful experience.
In the long postmortem on failed Viet Nam strategies, many military historians concluded that the massive firepower of the Westmoreland approach was inappropriate and devastatingly counterproductive. Early attempts at small local groups invested in the local communities—-a strategy vigorously asserted by our then chief of the Marine Corp—was squelched by the Johnson administration in favor of massive aerial bombing and huge suppression of the Viet Cong by tanks and napalm.2 Protecting the people from the Viet Cong was abandoned by a fixation on body counts. That massive kill strategy ignored the politics of collateral damage.
The US has finally learned that massive power projections often have countervailing downsides. We now try with small groups of tactically distributed forces in Iraq, Afghanistan and Syria, with much better results and much lower collateral costs. We do learn—-but it is a painful learning experience for both for our military forces and for the residents of countries torn apart by conflict.
Somehow, whether because of crony capitalism or national leadership failure, it seems there are now prospects of utilizing markets to deal with the treatment and vaccine development to fight COVID-19. By default, we are unleashing many non-governmental firms to search out the myriad of possible pharmaceutical answers to this pandemic. It is highly probable that we will learn more quickly with less direct expense than by a massive single effort by our national government agencies. That is what markets are good at. They sort out multiple paths. They follow small bits of information that possibly can be profitable as well as efficacious.
Sadly, some of the current drift toward collectivization is suffused with claims that profits will interfere with efficacy—-nothing is further from the truth than this canard. Bureaucratic collectivization is the long trod path of singular direction. The next battle will be the socially powerful claim to controlling the profits of the pharmaceuticals taking the risks ancillary to developing treatment and vaccines. This is the old story of Government trying to control the distribution of outcomes (income and wealth) through mechanisms with massive dis-incentives. When it comes to profits, politicians invariably forget old lessons. Killing the goose doesn’t produce new eggs. If the Government wishes to subsidize the cost of treatment or vaccine, it must do it in a way that does not punish the creators of these silver bullets. We don’t need to provide more examples of the Bourbons “learning nothing and forgetting nothing.”
Sadly, the talk in Washington has a punitive theme: “don’t let the drug companies profit from our misery.” Will politicians ever learn how disastrous such a policy can be? Subsidies for use of a drug are one thing. Suppression of pharmaceutical pricing is quite another. This is not a panegyric for unlimited monopoly pricing power. We should expect that private pharma will have a number of remedies for treatment. We want many approaches. Hopefully each will be thoughtfully vetted by good statistical practices and early use limited to medical emergencies until suitable validation is obtained. We will make mistakes. Drugs with subtle contraindications will occur and we will never be perfect in eliminating hard to discover side effects. We can take reasonable precautions, but we should not promote the illusion that there are risk-free treatments or perfect vaccines. In medicine, it is also true that perfect is the enemy of good. To offer such false illusions—-even by well-meant Governmental health officials—-is another road to nowhere.
Ultimately, herd immunity must be the outcome or we will have to live with future episodes of corona virus emergence. What we should demand of Government is rapid response to local upsurges and a willingness to allow multiple paths in emergency situations. We will not be perfect. We never are. But we can do much better than we have done, as long as the learning path is not so obstructed by the “good intentions” of politicians who fail to make necessary cost-benefit calculations. Doing better is a worthwhile goal. Doing it perfectly is an errand for fools.
Trump’s China Wrecking Ball Express
The recent arrest in Canada, under a request from the US, of the CFO of Huawei, the leading Chinese telecom equipment manufacturer, doesn’t seem to be an accident. In the context of the growing commercial dispute between China and the US, it will undoubtedly inflame the Chinese. In our view, it is a catastrophic strategic error. Was it merely an agency of the US government acting without Presidential instruction? Was this bad political governance or just an errant bureaucratic mistake? Either way, the consequences seem horrendous. Continue reading
The Credit Raters Oligopoly
Sometimes, the obvious solution to Agency Problems turns out to be impossible. Disorganized Crimes discussed to an obvious agency issue in the meltdown of the 2007-8 Credit Crisis. Who paid for credit ratings seemed to be an obvious conflict of interest problem for issuers of complex mortgage securities. Credit rating agencies competed for business of credit issuers, and the rating issuers didn’t want to lose issuer business by looking more deeply into the real credit quality of complex mortgage structures, and, more particularly, what could happen if the housing market went into sharp decline. Institutional buyers of mortgage securities needed particular ratings of these structured issues that would qualify them as consistent to their respective investment mandates. They were label and yield driven.
Everything was fine…until the wheels came off the mortgage bus!
Obviously, conflicts of interest made quality credit reporting highly suspect, deeply troubled by agency considerations. Solution: Have buyers pay for ratings!
Maybe? Maybe Not!
Along comes a new credit ratings agency with that kind of business model. The new Credit Rating agency business model seemed to be an obvious way to break up the credit ratings oligopoly? That’s what Jules Kroll thought, and his successful prior career in providing security to large firms seemed to make him a highly qualified entrant to the Credit Rating market.
Guess what? Credit portfolio managers like free lunches. Pay for ratings that known credit raters provide freely to the credit issuers? Didn’t happen! Kroll found it difficult to attract customers.
After struggling for a few years, poor market responses convinced him that to get customers he had to play on the traditional rating agency ball field. Let the issuers pay. Back to square one.
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What’s the real lesson from this market test? Markets don’t price extreme events very well! Credit crises don’t happen frequently and 2007-8 had some singular peculiarities. They are not an everyday event ,and in addition, there was a new regulatory regime in place after Dodd-Frank and the Fed got involved with financial intermediary balance sheets. Users of credit ratings didn’t place a high enough value on receiving credit ratings likely to be less influenced by the obvious Agency issue of having the issuer pay the Rater for its services. The obvious conflict of interest got very little attention, and few customers of credit ratings were willing to pay for them. Mr. Market spoke loudly!
A similar situation might be the relative lack of shareholder interest in comparative compensation data that Public Firms must now release when Executive Compensation plans are being established. That raises interesting issues on assessing the costs and benefits of regulations designed by regulators with the “public interest” in mind.
At the end of the day, the failure of a buyer-paid credit rating agency tells about how markets tend to diminish “highly less probable events.”
Sometimes the “obvious” isn’t really so obvious!
Why is Distrust of Politicians So High?
The Founders argued over successive terms for Congress and the Presidency but allowed life terms for Judges (subject to “good behavior”). Was this an accident or did they have a different notion of fidelity when it came to Judges as opposed to Legislators and Executives?
Was Montesquieu correct in asserting that Direct Democracy fell because of factions–majoritarian politics— and were the Federalists specious in their argument that the faction would have to win in each Sovereign State so that the argument made in Federalist 10 really does not hold up when one considers “vote trading” by representatives?
Cronyism is the market’s response to more rules and more distance from rule making .
The American and French Revolutions contained two embryonic themes brought down throughout history: overthrowing the power of absolute monarchy and to one degree or another, empowering the people’s representatives with the power to govern. A generic feature of the American Revolution and its enduing Constitutionalism was its evident fear of an unshackled executive authority as well as the fear that populism would lead to legislative majoritarianism. There was a corresponding faith that Liberty would create a multitude of economic opportunities that should remain largely unshackled. The dividing line within the Constitutional Convention was the need for a strong central government to defend the new Republic from external and internal enemies and the fear that too strong a central authority would usurp the power of the thirteen separate sovereignties that were giving up some of their authority to create centralized authority for the purposes of safety from abroad and domestic harmony within. The latter concern was often conjoined with a preference for transparency and a faith that local control — seen and disciplined by local voters — would limit the feared excesses of a State over its own inhabitants.
The rather sophisticated structure of “checks and balances” designed into the Constitution was always a compromised outcome that reflected the need to create Federal authority while preventing such authority from becoming a new absolute “monarch” all on its own.
The same thematic division still runs thru American politics: between political leaders who “know what is best for the people” (and who also dislike “market generated outcomes);” and politicians and political theorists who believe that creating opportunity is sufficient while favoring minimal interference with market determined outcomes.
At a philosophical level, “market types” believe political rights begin with paying strong attention to property rights and “control types,” who believe that the “people” have both a right and a duty to push outcomes in an egalitarian direction, because equal opportunity is not sufficient for justice.
Can Mudville Be Fixed?
In a previous essay, we lamented that Mighty Casey had struck out. Maybe what is needed is not another Casey, but fixing Mudville. That means changing our expectations of good governance and then doing something about a reduced menu of expectations. There are many sources of our disaffection with government. Our political fragmentation, however, assures us that there is not a single silver bullet. As a country we have very different expectations concerning what our Government should provide for us.
From an historical perspective, what we wanted in 1776 and later in 1787 was that Government should insure our liberty and our freedom. Those were simpler times and the Founding Fathers prescribed a stronger national government that could marshal the resources to defend our nation and protect us from violent uprisings internally. The Philadelphia convention of 1787 was highly fearful of the outbreak of domestic uprising, coming as it did shortly after Shays Rebellion was put down only through a massive effort by the State of Massachusetts.
The Founders wanted an orderly state, hopefully not torn apart by faction. Federalist #10 (Madison) was devoted to just that issue: factionalism, and how the separate sovereignty of the 13 States coming together in a Union would provide a protection against factionalism. The Fathers were also strongly aware of the precarious nature of our finances. The Continental Congress had made long-term sufferers out of its own Army by its failure to raise sufficient resources to pay the Army and its officers. After the Constitution was written, Hamilton, as the first Treasury Secretary, federalized the separate States’ debt thereby creating a viable financial system that could support the new Government and its armed forces. Tax revenues then came largely from taxes on trade—tariffs! It would not be until the 20th century that the US turned to personal income taxation. In spite of the brilliance of our Founders, history must judge their failure to place term limits on the legislature as a strategic error.
Term limits were thoroughly discussed during the deliberations in Philadelphia and while some limits had been in effect under the Articles of Confederation, they disappeared completely in the final draft of the Constitution. Even from Madison’s voluminous notes, it is unclear how this omission was contrived. Government was smaller and stayed smaller, absent the Civil War, until the advent of the Great Depression. Perhaps the small size of the actual government and the limited scope of its interests at the Federal level dictated that outcome? We cannot be sure.
The size and extent of Government’s intervention into private endeavors is very much at the source of the observed cronyism and corruption that so disfigures our current governance. It might seem strange that government size would be a source of corruption, given that smaller states also suffer the malady. Consider, however, the nature of any Government effort, either through specific legislative enactment or through the rules of a government agency designated by that legislation.
The bureaucracy writes the rules and largely interprets them even though the formal legal structure comes from the Congress and is signed by the President. Each activity that is so described by the legislation both prohibits or directs that private actors, firms, households, individuals, associations, NGO’s —all domiciled in the private sector—are to undertake an activity or to forsake an activity under the sanction of a Government regulation.
Each such regulation sets up incentives to abide by the directives but the regulation also implicitly sets up a shadow price that measures the value of non-compliance to the regulation. Thus, regulations set up incentives for behavior of agents in the private sector and clearly these agents respond to these incentives. Then comes the investigation of such deviations and the enforcement by the specific government bureau or agency designated to compel private behavior. How do markets respond to these incentives?
Largely, in the US, it is first by lobbying efforts paid for by affected private agents. The lobbying can take place in the designated bureau and/or it can take place in front of particular legislators. Here a quid pro quo often occurs. Private agents want a “seat at the table,” and they are wiling to purchase the necessary admission tickets. They can contribute directly to a sympathetic legislator’s campaign to purchase that seat at the table.
The absence of term limits has created many permanent politicians, each of whom requires resources to maintain his elected status. Markets work—often all too effectively—and we then observe special interests buying tickets to the cronyism and corruption circus. The circus never pulls down its tent. It is a permanent fixture of expanding government interference in the affairs of the private sector.
Now Mudville complains that its true wishes are not heard, that no one in Washington really hears what they want. That’s tinder for a political candidate willing to state he hears the cries of the disaffected. Sound familiar? Clearly, no joy in Mudville. Instead, we have frustrated grievances by a great many angry voters. Can representative government survive this tumult? One has to wonder?