“Major Strausser Has Been Shot. Round up the Usual Suspects”

—Claude Rains in Casablanca

“Casablanca”1 may have had a script fashioned on the fly, but some of its lines were epic. Unfortunately, rounding up the usual suspects has just been applied to the colossal failure of two banks, supported by their auditors very recently under current regulatory practices with a clean bill of health. How refreshing, to learn this after their prior equity holders were wiped out due to disastrous portfolio by their senior bank managers.

The continuing failure to write and administer proper financial regulation

The two usual “suspects” are the FED and the regulatory structure constructed after the disasters of 2001 and its recurrence of 2007-2009. Let’s get to the basics. Long ago, Milton Friedman told the JEC that his recommendations of a continual percentage increase in the money supply was not “theory.” It was practical advice to the FED not to behave as a counter-cyclical Central Bank. He argued for a stable monetary anchor. Instead, he told the Congress that the proper role of a Central Bank was to constantly focus on inflation and not to try to predict cyclical shifts in macro-economic behavior.

This FED, however, repeatedly shows itself to be politically astute at the expense of being a reliable monetary institution. It dramatically lowered interest rates to provide stimulus to an economy deeply troubled by Covid. Now, with the hindsight that the passage of time provides, many FED WATCHERS have told the FED that it was much too late in changing its zero-rate interest policy and got badly behind the curve in suppressing inflation. A poignant example of what Professor Friedman always warned us about once again. In theory, of course it would be a wonderful exercise if the FED could predict cyclical turning points and the appropriate lags in monetary policy so that the macroeconomy could avoid the ups and downs of the business cycle or the advent of a One-Off material shock like a pandemic. The evidence of that ability has yet to appear.

One might have supposed that the lessons of sending Bear Stearns into the arms of J P Morgan or subsidizing AIG’s failed portfolio management in 2008 might have changed the behavior of our Central Bankers—or that the monumental failure to bail out Lehman Brothers after the painful examples above—might have taught the FED and the Treasury about being late to the party. Sadly, regulatory “cures” such as Sarbanes-Oxley or Dodd-Frank were not good mentors to our regulators either.2 Those disasters were swept under the rug in the zeal of the Congress to fine-tune financial regulations that led to such poor results by external supervisors to monitor the financial sector of the economy. But again, we see that external monitoring is not timely and that auditing can be a paid-for service of “blessing” a client. KMPG was the auditor of both SVB and Signature Bank who gave these failed banks their approval. No doubt it was well paid for those efforts. Shades of 2008, once again depending on the auditing profession to miss the forest for the trees and get well paid while doing it.

Cardinal Talleyrand: Déjà vu

After Casablanca, my favorite reference is Talleyrand’ 1830’s summation of the French Bourbon rule leading up to the French Revolution. The witty Cardinal remarked, “They learned nothing and forgot nothing.”

We now hear the same nonsense from the Administration as it bails out unsecured demand depositors by creating a special provision to accept at face value the collateral of mid-term Treasury Bonds and Agency Debt taken on by the portfolio manager wizards. Those well paid managers thought they were maximizing shareholder value buying longer term debt with all the ‘fast money’ their depositor clients were taking in from Venture Capital. Monetary floods caused by FED-promoted zero interest rates seem wonderful until we see the damage caused at a later date. ‘Bourbonitis’ is a political virus for which our clever pharmaceutical manufacturers have not yet discovered a preventive vaccination. By the way, the disease is bi-partisan.

Bank Runs, Nash Equilibrium and Monetary Policy

The learning deficit in political economy is as long standing as the mordant humor of “Round up the Usual suspects.” Tax payers and voters should truly ask whether their governors in Congress and the Regulation Derby are doing the right job. And, it wouldn’t hurt for voters to be cynical over their answers or about the cost of bailouts.3

The monitoring process takes time and a random event intervenes to find the patient already suffering a fatal attack well before the monitoring process discovers and prevents the fatality. One wonders if the blame game will triumph over learning to be alert to the consequences of timing interest rate changes to perceived changes in macro-economic conditions. Some evidence of sales of equity stock awards by the managers at SVB prior to the huge bank runs that triggered their collapse will no doubt stimulate political accusations. Attempts to avoid such situations in the future would be more welcomed than current comments of our politicians. That is a minor lesson. The bigger lesson that surely will be too soon forgotten is how monetary policy can underwrite imprudent portfolio management.


  1. “Casablanca,” Warner Brothers, [1942] []
  2. As covered in my book, “Disorganized Crimes,” [2013]. []
  3. Diamond DW, Dybvig PH [1983]. “Bank runs, deposit insurance, and liquidity”. Journal of Political Economy91 {3}: 401–419. It is not to denigrate their contribution but to morn that our Congress and our bank regulators don’t seem to grasp the real lesson. The FED generally is late to the cyclical ups and downs of the economy, but so are the regulators. The Nobel citation is also humorous. “Their discoveries improved how society deals with financial crises”. Really? []

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

  1. 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

  2. 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

  3. 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 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.
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!

The Beast Is Not Starving

(originally posted 9 9 2016 but lost through Web Host error)

The EUs attempt to get Apple to pay $14.5 in back taxes is only slightly amusing. It actually quantifies what business and households will be looking at going forward. The raging needs of bureaucrats and politicians to spend the Publics money—doing good even when it turns out badly—is ubiquitous. Here are the EU bureaucrats, mad not only at the Brits saying they want to take their toys and go home, but now the Irish. Ireland hasnt said it wants to leave (so far!). Maybe a wakeup call has been rung in Dublin How does one say Brexit in Gaelic

The facts of the bureaucratic claim to the taxes are a scandal. First, Ireland as a sovereign can write its own tax laws. And, if in the judgment of Irish politicians, cutting the corporate tax rate for Apple was good for Ireland, why is Brussels sticking its nose under the tent, now The answer is manifold.

First, the EU needs lots of money. The poor economics in the EU dont generate enough taxes for the Bureaucrats and the Europols. They need to be seen as doing something and that takes money and that rhymes with funny. Apple makes a lot of money—and in Euroland—making profits is sinful. Were it not, the ECB wouldnt be buying corporate debt!

once said that history repeats: the first time as tragedy, the second time as farce. Can there be a bigger farce than telling a Euroland member that what that country does to better the circumstances of its own people is not permitted This is political misgovernance gone berserk.

Well, the times are berserkLook at our Presidential election: Greshams Law applied to American governance. The Bad drives out the GooSecond, the Brussels gang doesnt like sharp differences in corporate tax rates between Euroland victims. Everybody should raise taxesparticularly the Euro members that think lower corporate taxes mean more business and more employment. So a deal made many years ago when Apple wasnt the powerhouse it is today simply stinks in Brussels. Its Unfair. Worse, it allows Apple to expand and do more of what it does best, innovate and disrupt.

Third, and here we can only conjecture, but the EU is also going after innovative industrial leaders: read Google, and Microsoft and individual countries in the EU (France) dont likeUber! Whats common here is that all four countries are innovative and disruptive.! And Europe values its quieteven at the expense of torpid growth. No one has to save a rich and growing countries. Bureaucrats need poor countries or countries that grow poorly to underscore their importance. Marxd. In a year in which by all rights the Republicans should have steamrollered the Democrats and captured the White House, as well as the Congress, the noise of the disgruntled allowed Republicans to choose someone who wants to march us back into a history of nativism and knownothingness. Some voters are bound to say, Well, it’s the year of the woman, even if she manipulates the truth as if it were Play Doh.

We are going to get the Governance we deserve, arent we


Big Government-Big Cronyism?.and maybe a bit of corruption too?

Kim Strassels op-ed (The U.S.Department of Clinton) WSJ 8/25/2016 put her writing finger on the real HRC issue: there was no line between her activities as the Secretary of State and as Secretary of the Clinton Foundation. The crossovers are too numerous to catalogue, but will motivate ambitious expose journalists who will mine this story for all that its worth. And, it could be worth a lot, particularly if HRC succeeds in wasting her opportunity to become the first woman President.

After the slow but steady drip of importunate details of her many crossovers between pubic and private service, it becomes even clearer what Big Government has done to an electorate badly in need of no conflict of interest public servants. Hard to find, Harder to elect.

For many years, the SEC and the FCC and NLRB—along with all the other alphabet of Washington regulators has been a revolving door between public service and private emolument. For those who wish to endow their human capital with a fat rolodex and many shoulder-rubs with the powers that be, a few years writing papers for the higher ups, commenting on policy proposals, doing the case work on a forthcoming prosecution, etc. is an apprenticeship with fine rewards at the end of ones stay within the Beltway. Not only do the public service neophytes learn whos who in the power ladder, but they also learn the techniques of rolling their log in the tree pond in exchange for favors done by counterparts and higher-ups. Is it any wonder that these loyal knights of the realm have trouble finding the clear line between public service and private reward After all, they do their government apprenticeship with the firm belief that it will come in handy in the private sector. And it surely does.

The HRC affair has exploded because of her candidacy. Expose passes for election policy statements these days. This will be one of the dirtiest campaigns on record, but it is a mere mirror of the filth of private ambition coupled with government power.

The Clinton Foundation should get a marketing reward and acase study of how it managed to gather so many supporters worldwide. The case will be taught for years in Marketing courses for MBAs. The Pay for Play scandals in New York State wereonly the tip of the iceberg in comparison to the major access stories now seeping out. Pay for Play, has long been a staple in winning Municipal Bond underwritings, or in insurance contracts, etc. What is the real lesson for voters and citizens to take in from the HRC/Clinton Foundation tight linkage

Very simply, this is what Big Government comes to mean in a world of Big Industries, Big Banks, Big Insurance, Big MediaIt is well understood that Bigness produces Big Compensation in the corporate world and being a Big Person, puts you in line for the rewards that Big Government can throw out. Cronyism is the market response to regulation—to insuring that any new regulation does as little damage to your Big Firms interests as possible, or even better yet, your Big Firm gets a carve out exemption!

What is the difference between cronyism and corruption: the explicitness of the payment for getting the deal done But that is a very thin, almost unobservable line. In the HRC/Clinton Foundation case, draped as it is with the robes of Charity, it was clear that to get access, donations were the ticket. Become a friend of the Foundation and you got access. The quality of the access and what was paid for it still has to be measured, but that will come. Some enterprising journalist looking to make her bones will be able to compute the regression equation.

Our major point is that the bigger the government, the more intrusive government becomes in everyday life, the bigger the rewards for individuals who can blunt the charge of government regulation. Big Government provides the incentives for cronyism. and for corruption as well.






America?s Leadership Deficit and the Art of Political Pandering

If you were hoping that Americas Leadership Deficit would end this November, you are going to be sadly disappointed. If the Republican debates didnt destroy your hopes for meaningful change, it is highly unlikely you will find your enthusiasm lifted by watching the Democratic debates.

Last night, I decided to tune turn off a reasonably competitive basketball game to glance at the latest Clinton-Sanders soap opera. I could stand only about 15 minutes. The debate was moderated by PBS anchors no doubt to emphasize that this year the US can (and likely will) elect its first female President. Will that remedy our leadership deficit la mme chose.

When I tuned in, the two candidates were resorting to their typical sophisms that characterize American political discourse. Theyshowed no specific remedies other than throwing more government resources at the problems, and advocating higher taxes on the “rich,” to pay for it. The rhetoric of treating American social failures was predictable. The solution set ofeachcandidate was truly null and void.

Sanders excoriated the truly lamentable statistics on the number of Americans now in prison—which he claimed without any substantiating evidence— now exceeds the totals imprisoned in China with a population five times greater. (Hard to know his source of information on the Chinese penal system). Forgetting the hyperbole, it is true that at the end of 2014, over 1.5 million people were held in American prisons. It is sad, never mind the Chinese comparison.

The candidates focused on the composition of the male prison population that includes some37% black males, 33% Hispanic males and 22% white males. No gender equality found here! Moreover, and this was the real point of the debate—drawing in minority voters—the most obvious remedy was overlooked, and their attention centered almost exclusively on cleaning up American police force methods and police profiling. They ignored the fact that more than 50% of those incarcerated got into prison via convictions for drug offenses. The obvious solution—repealing our current drug laws—was never mentioned. Instead, our criminal justice system was condemned for carrying out the laws that legislators such as these two have passed or allowed to remain on the books.

Neither candidate —at least during the few minutes I could stand to watch—took up George Shultzs recent Op Ed piece in the WSJ (“We reduced smoking, why not drug use” 2/9/2016) that focused on the abject failure of our War on Drugs. Doing that should have been obvious, but these two candidates werent really interested in effective solutions. They were interested in pandering tovoters. Since non-whites aresome 70% of the prison population, it was obvious that discrimination against non-white drug offenders was rampant. With low skills, poor education, deficient family structures, are we surprised that the lucrative earning power of dealing drugs by unemployed and unskilled males is compelling Neither candidate questioned whether the real problem in America was punishing people for their sumptuary preferences and the large economic rents these productsgenerate to those willing to risk catering to that demand. Instead, what was recommended was teaching policemen to be unprejudiced in their law enforcement efforts and making the racial composition of the police forces mirror the racial composition of the neighborhoods they policed.

We dont have to exonerate police who have frequently used racially focused tactics, including unofficial racial profiling, when they arrest suspects. Even with explicit withdrawal of racial profiling, policemen know the stats and their arrest behavior is understandable. The problem is not profiling: the problem is our drug laws are out of step with the population and our War on Drugs tends to arrest the foot soldiers of drug distribution. Regarding the nature of the social ills that our society suffers, tastes have changed. Marijuana is not viewed as a scourge. Many states allow its production and use and some its distribution, taxing the drug that they cannot control with police and prisons.

What cries out inany rational assessment of Americas drug demand is that we need to reduce the gains from dealing drugs. That means ending criminal prosecutions for these offenses and making our police instruments of civilian safety, not alocal drug gendarms. As for usage of harder drugs, Schultz cited the clear and well-documented drop in smoking that stemmed from well-documented research coupling smoking to serious diseases. What counts is to reduce the demand for dangerous substances, and not creating a black market in drugs that draws in the uneducated and low-skilled populations who distribute such products. Ironic and sad it is that two legislators, now Presidential seekers, dont focus on the obvious changes in our Federal criminal statutes that would reduce the scope of the problem. Neither do they put forward a solid program for instructing our people about the consequences of (hard) drug use. Americans growing use of drugs is not dealt with. Instead, Americas police, who try to enforce a much-outdated set of laws, are the whipping boys to advance these candidates electoral interests.

Perhaps the most cynical attack was from Sanders. He advocates more education in prison; re-training of prisoners; early release and continuing government transfer payments to low-income individuals. Any one who looks at the rather unfavorable statistics of retraining or improving education has got to feel that simply throwing more Federal money at the problems of low income, low skill people, is not going to be more effective than it has been to date. That is political escapism, at best, political pandering at worst. What it is not is real political leadership. That deficit is not going away soon!

In modern society, those that are poorly educated, poorly socialized and vastly unemployed gravitate unsurprisingly to benefitting fromthe rent streams that our faulty laws produce. What is needed is to reduce those rewards. That would berelatively easy, if not a sexy political pander job. Is that not obvious

Why dont the candidates deal directly with the problem and advocate realistic changes in our drug laws The answer is that would require real political leadership. The candidates, if they are expert in anything, are masters of pandering to the voters and offering more bread and circuses. Sadly, Americas leadership deficit is not about to end.


Leaderless Politics and the ?Immigration Crisis?


  • I was pleasantly surprised by the positive reaction I received to my blog yesterday1. For those of you who wrote in, thank you. That said, I wanted to rewrite it, but didnt quite get to it. I would have changed the title to read Failed Leadership: organizing disorganized crimes.” Why As I have thought more about the woeful state of the world with its wide-spread absence of good leadership, it seemed to me that when important institutions and organizations suffer from a leadership deficit, what might have otherwise been disorganized crimes, are more likely to become organized criminal activity.
  • At first blush, this might seem paradoxical, but common sense and thoughtful reflection provide good evidence for the proposition. A family that suffers from inadequate parenting creates risks for its children. The data on this are overwhelming, and most of us know this from our own life experiences. Mentoring a child is terribly important to the childs progress. Professor Gary Becker, who made his life work the study of Human Capital2in its various dimensions, gave us a model to understand this process. Parents invest in their children by educating them and leading them with good role models. In general, more investment in those children leads those children to higher levels of human capital, and as a consequence, the choices and opportunities open to children with higher human capital are better and last longer. They tend to finish high school with greater frequency. They go on to college in greater numbers. They get better jobs and their lifetime incomes are substantially higherthan those with significantly lesshuman capital. They live longer and as a group, they experience less crime and far fewer penal outcomes.
  • You can reverse that causal sequence in a poorly parented family. An absent parent is not a leader. A single parent has greater leadership responsibilities and often, single parents cant carry the load of being both a breadwinner and the leader in the family at the same time. In a family with poor leadership, children are first disorganized and then they become self-organized by leadership outside the family. Some of those leaders outside the family provide unhealthy lessons for these children. Mentoring by outside “parents” can involve joining a street gang or becoming attracted to the drug trade. It often leads to poor schooling experience and an ultimate drop out. This is why the absence of leadership is critical. Deficient leadership can convert disorganized lives into organized crimes.
  • The inference we draw from this sketch is that rules organize human activity and that social organization works best with good leadership. Whoever leads generally follows some schema of rules but not all rules are good rules. Bad rules are often based on an uninformed prejudice, not credible facts. Some prejudices become the fuel for outrageous displays of Xenophobia. Xenophobia lies at the root of the so-called Immigration Crisis. Is it a crisis, or is there substantial misperception, deliberate or otherwise
  • No area of American (and European) life seems more fractious than the issue of immigration. Xenophobia also runs through European politics. Sadly, it is infecting the American Presidential campaign.3. In our view, the immigration crisis, is largely based on bad data or in the worst cases, no data at all supportive of such xenophobic contentions. In the era of Big Data, it is shocking to see those claiming to be leaders, basing their outrage and their solutions, on such an uninformed basis. It is particularly shameful for those who claim to be true conservatives or libertarians to fall prey to these claimed facts that are simply not true.
  • Poor leaders thrive on phony data, on facts that are untrue, or on lies that are politically expedient and dangerous to the body politic. Have we learned nothing from the horrors of World War II as well as all the other ethnic cleansing stories in recent years from countries led by awful officials Repeated intensively, the big lie, becomes the factual basis of a terrifying cure. What is the Mexican problem, after all—a revival of the Jewish Question We should know better and we should demand that our potential leaders immediately stop pandering to big lies. It will take courage for these candidates to get their head wrapped around the real facts and our own American historybut isnt courage one of the vital qualities that we look for in our leaders To lead well, they must begin with the truth.
  • As I have listened to these debates from alleged conservatives, I could not help but think, not only is the US suffering from a huge leadership deficit, but campaigns such as we now observe, extend and intensify that leadership deficit. Over the long run a leadership deficit will bring more trouble to this country than a fiscal deficit. We can cure the latter even in a modest amount of time. We reduce the size of government and much of the fiscal deficit will disappear as economic growth takes place. All of this is so well known by those who wish to know that it scarcely seems necessary to point it out. Yet, immigration, legal or illegal, has become the whipping boy of slow wage growth, increased crime and an expanding fiscal deficit. Resort to such factually empty explanations only underscores our growing leadership deficit. What about immigration, then Is it or is it not a serious problem
  • This country was built on immigrants. Immigration, particularly the heavy immigration of the later half of the 19th and early 20th century was positive for growth, positive for the growth of real wages and positive for the existing residents and surely positive for the immigrants. Those were years of mighty economic expansion, but note, there was no welfare state. That is a big difference as compared to today. The economics of that period is well understood by economists. Yet, some economists think that our immigration problems today are different. They are and they arent. Lets carefully understand where differences between our 19th and early 20th century experience and our current circumstances in the 21st Century lie, particularly since the 2007-2008 economic crisis.
  • The late Professor Milton Friedman made the issue of immigration totally clear years ago to Americans of every political stripe. As frequently happens, however, lesser men and women didnt understand or distorted what he said. Worse, they misquoted him and turned his powerful logic upside down. Heres the long and the short of it.4
  • The existence of the Welfare State changes the game. A legal immigrant by definition lowers welfare of those already here! An illegal immigrant raises welfare! Thats a paradox that seems at first blush difficult to understand. Clearly the Presidential candidates dont understand it. But, it is actually quite simple as Professor Friedman explained. It all depends upon who gets the welfare!
  • Suppose that all legal immigrants are entitled to the welfare benefits that existing citizens possess once they enter the U.S. And, for the simplest case, imagine that the sum total of all these welfare benefits amount to a trilliondollars (of course this is just a simple illustration). Further,imagine that there are no new immigrants in the first instance. Then, the per capita welfare benefit of a trillion dollars is divided over the existing population (excluding immigrants). Now suppose new immigrants (legal and illegal) appear and are entitled to the same benefits By definition, the rest of us suffer a diminution of welfare. Of course, our leaders can easilyincrease the welfare budget and laythe expenseon future generations. In either case, our welfare declines.
  • Now suppose there isonly illegal immigration An illegal immigrant cant qualify for benefits (when the rules are enforced). Thus, if a million illegals enter, the work force expands, (more GDP) but no more is spent on welfare than before they came. Whoops! Welfare for the rest of us goes up, because output goes up with no extra Federal Expense! Wheres the rub Simple: if you dont have a welfare state, then immigration (of either kind) is beneficial because output rises. Professor Friedman concluded that as long as we have a welfare state (which we are not ready to truncate), legal immigration can reduce our welfare, but illegal immigration, where welfare benefits are strictly enforced and illegals dont qualify, is welfare increasing! Ok, Candidates! Wrap your heads around that one!
  • The Candidates have it exactly wrong. They should all either agree to abolish the welfare state—in which case legal and illegal immigration benefit the rest of us—or they should permit only illegal immigration and enforce the law!
  • There is a moral to this story. If we have a rule, we need to enforce it. If we have a welfare state that we are unwilling to give up, then enforcing rules is very important. Politicians who find ways to leave rules unenforced, walk our citizens into a trap. But that is what we observe from our politicians who have huge leadership deficits.
  • At the end of the day, most of what comes out of the so-called immigration crisis, is gibberish in the best case, awful pandering or the Big Lie in the worst of cases. And, dont forget, at the base of this pile of dung, there are politicians who have failed at their most basic task: to be leaders. World history offers literally endless examples of States gone sour when their leaders failed to properly lead their citizens. Our founding fathers knew this, and they were deeply worried about how to prevent the future destruction of the Republic they had delivered to the world.
  • They started from the Articles of Confederation that had produced a weak national government and left the citizens of the new Republic as potential victims of foreign powers who would meet a fractured and weakened country. They labored in Philadelphia to produce a founding document that would answer the observed defects of prior, failed Republics. Together with the first 10 Amendments (The Bill of Rights, demanded by the Anti-Federalists as remedies to absolute power by the State), they produced a remarkable document. The Constitution has flexed and swayed and adapted to the exigencies of a rapidly growing country, suffused with immigrants who were building the New World. Implicit in this construction, however, was the need for thoughtful, courageous and diligent leaders. We were very lucky to have survived the early years of the Republic.
  • You know the rest of the story. Fourscore and seven years ago. To advance the cause of liberty and freedom, we found ourselves in a great Civil War that tested our principles and our leaders. Fortunately, when we needed them most, we did not have a leadership deficit and we entered the 20th century as a surging, growing, expanding, young nation ready to take on the world. We did it with masses of immigrants who arrived here looking for a better life than the one they had left. Those immigrants did very well, and so did the residents they joined. They were a powerful force for building America. We absorbed them, and they helped to transform America. Germans, Irish, East European Jews, Italians and a multitude of other nations and cultures. They took the jobs that those already here were not willing to take; they raised their children, they learned our language and our customs and they rose or fell strictly on their own efforts. There were no requirements for entry into the U.S. until we again got that immigration crisis mentality and started to restrict who could come here and under what conditions in the 1920’s. In the years after World War I, we had a series of business cycles that disrupted and changed America. Immigrants were blamed again. We began restricting entry.
  • We are now living in difficult times when many more demands are placed on Government to help the disadvantaged, and create a security blanket for those already here. When the immigrants come today, they dont face thenarrower government of the 19th and early 20thcenturies. They see an expanded Welfare State and by neglecting the rules, we have gotten into the habit of passing out the benefits to newcomers as well asexisting residents. That makes some people mad, but their causal reasoning is terribly faulty. We dont seem to have leaders willing to tell them the truth. Instead, we have politicians who want to use the immigration crisis as a path to office and power.
  • We have seen this movie before. Its time to shut it down. We have to stop confusing the so-called immigration crisiswith the problems that stem directly from the Welfare State we have created and the ‘leaders’ who run that state. Lets face it. We dont have an immigration crisis. We have a leadership crisis. Its time to put the leadership crisis to bed.










  1. DISORGANIZED AND ORGANIZED CRIMES: failed leadership and its consequences []
  2. Gary Becker,Human Capital: A Theoretical and Empirical Analysis, with Special Reference to Education, UChicago Press []
  3. The Immigration Boogeyman: Separating Fact from Fiction, at wharton.upenn.edu, 9/30/2015 []
  4. What Milton Friedman really said about immigration,Classically Liberal, May 8 2008 at freestudents.blogspot.com/2008/02/what-milton-friedman-really-said.html []

FAILED LEADERSHIP AND ITS CONSEQUENCES: disorganized and organized crimes

It has been an amazing past few weeks. In less than a month, we have witnessed massive failures in political and economic governance world-wide and a moving spiritual appeal for individual responsibility by the Pope on his visit to America. The Papal message of individual responsibility (self-governance) was combined with an extraordinary focus on those left behind. It was was a badly needed rejoinder to the leadership failures we see every day, here in America and elsewhere as well.

The political and economic malaise that is evident globally stems from an appalling lack of leadership in both government and industry. The Pope stressed the importance of spirituality in motivating personal responsibility. His visit was a stunning display of respect for individual lives and a call for individuals, institutions and countries all over the world to address global problems with compassion and charity. Our politicians and business leaders have undermined our trust in government and business. Sadly, they seem not to have heard the Pope’s message. They neither lead nor do they listen.

Among our current economic and political failures, we can include:

Massive migration into an ill prepared Europe stemming from four years of warfare in Syria and Iraq. The failure of Western leaders to marshal sufficient resources to cope with the breakdown in Syria and Iraq and the growing strength of ISIS, who now controls the largest amount of territory in the two states combined, means emigration into Europe will dominate political life in Europe far into the future. The flood is only beginning.

Russian military intervention in Syria that underlines the failed leadership in the US and in Europe to deal seriously with the Syrian disaster. Leading from behind has been demonstrated to be a much-faulted strategic conception combined with feckless political leadership. Put simply, leading from behind is not leading at all.

Iranian Nuclear deal that now goes into effect is not a treaty (that would require two/thirds approval by the Senate), but as an executive agreement. Leadership that skirts American constitutional process in order to ram home an agreement whose full terms have not been disclosed is a travesty to our traditions of governance. Those who lead in this manner show a total disregard for allowing the judgment of the people’s representatives. Whatever the outcome in Iran, here in the US, it is a bad example to follow.

Unexpected resignation of the Speaker of the House shocked the politicos within the beltway. It leaves the Republican opposition disorganized and the Administration praying that the Boehner walk away will at least provide passage of continuing resolution so that the Government will not be shut down. The shambles into which the Republican Party has fallen is not a good omen for political governance. We are reminded of Ring Lardners great baseball quote. “Although he cant field, he cant hit either.”1This leaves non-elected officials (such as the Supreme Court or the Federal Reserve) in charge of policy. Leadership failure has very long term consequences.

Growth slowdowns in emerging markets have thrown prices for basic resources into the toilet. The effects on employment in the resource industry have just begun, but the effects on the prices of resource stocks have been devastating. In case you havent noticed, equity markets worldwide are in a state of panic. Partly, the collapse of basic resource prices is responsible, but not entirely. The loss of direction in economic policy displays the same failure of leadership noted in the political arena.

Federal Reserve vacillation in choosing a definitive policy stance and communicating its direction going forward has added to the bearish movement of equities. The best characterization of the FOMC may have has been the recent translation of its acronym: the Federal Open Mouth Committee. The Fed has pulled a Lucy, as one economist has pointed out.2If the Fed knows where it’s going, it hasn’t let the market in on its big secret.

Exposure of Volkswagens fraudulent auto emissions gimmick is just the beginning of a continuing set of disclosures that reek of massive failures in VWs corporate governance. The damage to the worlds second largest auto manufacturer is incalculable at this stage. The damage will not be limited to VW. The German auto industry employs one of of seven in the labor force. The consequences will be manifold. Government has failed as well. VWs contravention of environmental regulations in both Europe as well as the United States indicates the regulators on both sides of the Atlantic were asleep at the switch or perhaps suborned from their real duties of protecting the public. Public confidence in government regulation should and will fall sharply. Our trust in our governments falls when leadership fails.

Disorganized Crimes has mainly focused its attention on continued examples of corporate misgovernance in the US. However, we have always thought that corporate governance is a subset of a larger governance structure that takes account of government, the courts, and our institutional arrangements. Those institutions include what we term as the regulatory state. And, no state today, is without that panoply of regulatory bodies that effect day-to-day governance. We have all become dependent on this massive regulatory state to guard the public interest, the more so when individual shareholders cannot control the operations of the companies they own. The parallel to 2007-2008 is striking. Firms failed and the regulatory bodies failed with them. It was not a case of deregulation. It was repeated failures to apply the existing regulations. Don’t let the government deceive you by blaming the “other guy.”

What we are witnessing in the VW disaster is a twin failure: the failure of corporate governance at VW and the regulatory failures in Europe and America. The regulations are suppose to stand guard for the public. The agencies charged with overseeing compliance to environmental law have behaved as dupes over a long period. They remind us of the investors in the Bernie Madoff scandal, each relying on their friends continued investment with Madoff to assure themselves that nothing was wrong. When business leaders in public companies fail, shareholders can and now often arise to throw out failed executives. When government regulators fail even to execute their own mandates, the public interest is not only trampled but citizens lose their belief that their government will be there to act in their interest. What then

What should we make of this extraordinary regulatory failure Clearly, the leaders of these agencies have failed to lead. They are not even able to carry out the regulations they demanded to be placed on the books. It is scarcely satisfying to see these failures in virtually every country irrespective of its political ideology. No matter what the ideological underpinnings, regulatory failure is also leadership failure. It undermines our belief that somewhere, someone is paying attention to the needs of the citizens, and doing it competently, honestly and regularly.

Where does the public go from here In 1961 John F Kennedy aroused the passions of many Americans with his clarion calI: Ask not what your country can do for you! Ask what you can do for your country.3 The exact quote is And so, my fellow Americans: ask not what your country can do for you, ask what you can do for your country. The public needs to turn this phrase around and ask ‘What is Government, which dictates so much of my life, doing for me’ Can Government keep me safe from terror, from economic decline When I retire, will there be sufficient resources for me in my old age Will the national health plan be there when I fall ill Can government provide the moral compass to judge who are the organized criminals in our society Maybe not Maybe I ought not to trust my future to a government that seems to function in a directionless fashion headed by leaders who are leading from behind

By his speeches, and the locations of his visits, the Pope seemed to be saying, Do what you can to alleviate the suffering in the world. It is your responsibility. It struck a spiritual chord in America that our deficient political leadership would do well not to ignore. Politicians and administrators who fail to lead, lose the respect of their countries citizens. In the next emergency, if government is not respected, government can no longer lead. Who then will follow

This past week provoked me to remember the actor Peter Finch crying into the night in the movie Network, Im mad as hell and I am not going to take this anymore.4 People in America are mad as hell. Who can blame them

They are mad in Europe. They are mad in China. They are mad in Russia. The flood of immigrants into Europe are not only mad, they are escaping a geography that is no longer a state.

When we speak of the United States, we think of an organized polity with recognized borders, recognizable leaders who direct our attention and to whom, ordinarily, we accord our respect. That is not our present State of the Union. Today, in America we are ‘mad as hell.” Are we going to “take it anymore”

  1. This is how I remembered it from my youth. Looking it up on the web, the best I could find was Although he is a very poor fielder, he is a very poor hitter. I may have read the remark in an old Grantland Rice book and to me it reads better as it is in the text. []
  2. David Malpass, “The Fed Pulls a Lucy,” WSJ 9/17/2015 []
  3. John F. Kennedy, Inaugural, Washington January 20, 1961 []
  4. Network, United Artists (1976). The speech and its repercussions can be found at https://www.youtube.com/watchv=q_qgVn-Op7Q []

The Oracle of Demos on Corporate Governance

When I read the title of the New York Times (NYT) editorial today in (Keeping Shareholders in the Dark 12 3 2013), I was curious. I was even a bit joyful thinking the Oracle of the Demos (NYT) had finally figured out an essential element of improved corporate governance. Joyfully, I thought, the NYT gets it, finally! Was it really possible that a press organ so devoted to enlarging the mission of government was going to investigate the non-disclosure of risk taking that currently characterizes the activities of so many of our largest public corporations Wouldnt shareholders have liked to know about what really had occurred with the London Whale (at JP Morgan) when the shock of huge losses were first disclosed In the campaign to make markets work better, an ally such as theNYTwould be a welcome addition indeed. It turned out to be a false hope. Continue reading

The Punishment Puzzle: Who’s the Fish in this game?

A distinct absence of news now seems to be occurring in the “chicken” game between the US Government and JP Morgan Chase (JPM). What seemed to be a settlement, waiting only the fill-in of the numbers and the JPM confession, now seems to be hung up. The absence of news is striking. Something is going on. What seemed to be a Punishment Cycle maybe evolving into determining who is Fish in this game. Continue reading