Hysteria and Denial: the Dragons’ Teeth of current American politics

Firm believers in the American Experiment are no doubt deeply troubled watching the evolution of the 2016 nominating campaigns. Troubling may be too tepid a description. For some, it has become outright despair. Has the brilliant experiment in a self-governing democracy ended in a wave of hysteria, hyperbolic rants and suggestions that violence is an appropriate mode at a political rallyThis campaign reminds some observers of the failed Weimar Republic of Germany in the 1920s.

The candidates oscillate between outright fabrications of asserted facts and tendentious policy recommendations that have little chance of passage on Capitol Hill during the next Presidential term. Or do they Are we at the beginning of a political revolution that threatens our 240-year-old experiment

Is it possible that the newly emerging extremist plurality will cram it down the throats of the sliced and diced minorities that make up the balance of the electorate After 13 years of war overseas, and nearly 15 years since 9-11, the public appears too tired to carefully examine the underlying premises and the policy rubbish thrown out by the three remaining candidates.

What is perhaps most distressing is the voluble rallies that feature the worst of extremist pronouncements. Bernie Sanders wants to finance a massive further intrusion of the State into the economy—although no respectable economist can confirm that his tax proposals are viable. The more likely outcome is that to finance these additional Government efforts, not only will there be gaping deficits going forward, but the deficits themselves will cause a huge retreat from US Government Securities. The ensuing rapid rise in interest rates will force even the present level of government expenditures into a growing and massive Government budget deficit. Yet, Sanders is cheered by the 21st century’s version of the No Nothings. Their shouts of approval blot out any thoughtful political discourse or examination of the substance of his proposals.

Meanwhile, the debate between the two front-runners, Clinton and Trump has become the political equivalent of the old saw that the second liar has no chance! If you listen to The Donald, you have to conclude there is ‘no manufacturing left in America,’ despite the fact that the value of U S manufacturing has never been higher! He doesnt want the voters to know that. Perhaps, he doesnt know that either! What is true is that it takes much less labor for the manufacturing sector to produce its higher output. Productivity—the real source of economic growth—has risen sharply over the past few decades even if it appears to be slowing at present. It is also truethat the most recent data continue to show rising employment and output—which is what we should expect if productivity continues to rise. Growing output and falling employment are reconciled via growing productivity. The key fact is growing output—but that is absent in the political discussion. The discussion should be on how to raise productivity in order to make the economic pie grow.

One might ask Trump how can we begin becoming more productive again The question is never raised because the discussion starts with we are losing. The mistrust in which Clinton is held shows up in her favorability ratings that are essentially as bad as are Trump’s. Clinton’s policy measures move steadily toward her Democratic party opponent’s solution fantasies. What you hear depends upon which day you listen. Each of the candidates obscure the facts. It stretches ones faith to believe that they know anything about how the economy actually works.

Why is it that these facts never enter the current political ether The answer is that the candidates dont want the voters to which they are appealing to understand the real facts. Maybe the candidates are themselves are ignorant, but their advisors arent even if they are disingenuous. They are surely quite familiar with basic economicstatistics. How then explain the collective political spin of candidates on the far left, and the ordinary left The answer is simple but repugnant: many voters are unhappy with their own personal outcomes. That is the mass that the candidates wish and need to attract. If the country is getting richer, why are the horizons of this mass seemingly contracting Whose horizons or outcomes are improving Aaaah! You know who is doing well! Take it from them and give it to us! It is not the first time that a pariah has been found to provide an easy political answer.

Once you start with that kind of political arithmetic, the Democratic assault on Wall Street, the “Banks,” the 1%, or the special interests that finance these political campaigns, the conclusion is obvious. The politicians need to convince you that all that is needed is to redistribute the outcomes. The basic message on the left side of the aisle is that it is high time that the inequality of outcomes becomes the central theme of the campaign. The problem in their view is that the pie isnt growing fast enough now, so its time to recut the portions! the real problem of making the pie grow faster is simply ignored.

What about the other side of the aisle Is Trump running from the right or the left Here, we have the answer to the conundrum of the putativeRepublican nominee. Somehow, the Trump campaign has to define the them that is the cause of the current unhappiness. He can’t indict his own class! You dont have to look very hardto find them. If the fault is not “ours” it must be coming from outside. The foreigners and the illegals are his “them.”

Look carefully at the Trump attack points: unwanted and illegal immigrants; cheap Chinese labor combined with the theft of American invented technology; American expenditures in solving problems in foreign countries. Each of those targets consist of non-voters. Trump identifies the source of our problemsas lying outside our political boundaries. Its them, not us! The answer then is to do better against the them! Keep the illegals behind the Wall and build more Walls to keep out cheap imports, and place restrictions on where America spends its blood and treasureoutside of our continental boundaries.

As to how to start winning, elect a Winner! The drumbeat is the evident stupidity of the current politicians and bureaucrats of Washington who dont know how to win. They never ran successful businesses. They exist on the support of our taxpayers and then they give away Americas rightful place in the world. The answer to start winning, is to throw out those Bums and replace them with someone who is an evident Winner.

This raises a most difficult question: can democratic self-governance work in a Kingdom of Lies Have we passed the point of no return where the Big Lie becomes the only driver of political success Of course, if you trust one or the other of the candidates, you are leddown his or her path,accepting their assumptions and their respective conclusions. But believing in fantastical conclusions doesnt make the conclusions correct or their remedies likely. Treating a sick patient with the wrong medicine because you have misdiagnosed the problem can only result in tragedy.

There are historical parallels to our current political morass. In the 1850s, the American political spectrum was badly divided and the existing parties (Whigs and Democrats) were factionalized. Neither could provide a solution. Within each of the old parties, there were serious divisions over the issue of slavery. Only a new party that grappled directly with the issue of slavery could do that.

The Republican Party was formed in 1854 in Ripon, Wisconsin. The new party incorporated many of the splinter parties of the times (the Free Soilers, the No Nothings, the Liberty Party) plus segments of northern Democrats and Whigs.

The Republican Party ran an unsuccessful campaign in 1856. The country was rent by the issue of slavery and the threatened secession of the southern slave states. During his unsuccessful Senatorial candidacy in 1858, Lincoln uttered his famous line a house divided against itself cannot stand. Shortly after his election in November of 1860, his prophecy came true. The bloodiest war in American history followed at a terrible human cost. The Union would have failed under a less resolute and far seeing leader. The political lesson is clear.

The existing structure of our two party system has failed to address our current problems. Each party fails because it combines too many internal contradictions to allow for a clear solution path. American politics is at an impasse because the centers of each party have more in common with each other than within the extremes of their own party. “Centers” don’t provide the needed extra votes necessary to win an election. It is the “extremes,” where the candidates focus. Attempting to overcome those internal divisions, the candidates are now attempting to draw in new blood, by hysterical appeals that mislead the public with solutionsbound to fail. This leads to extremist appeals. What is needed is a massive political realignment. This is not new dilemma in American political history. It has happened here before.

The 1850s and 1860s also were terrible times of hysteria and denial. America was fortunate then to have a (minority) President dedicated to saving the Union butwilling to incur a terrible price in doing so. Lincoln did not begin as a dedicated abolitionist. While he hated slavery, he began first by trying to save the Union. In the process of the terrible Civil War, he moved from emancipation to abolition. What made Lincoln unique was his combination of morality and acute political insight. He fashioned a winning policy out of opposing forces within his own cabinet and within the Congress while enduring a succession of failing military leaders. Despite the considerable internal pressure from opposing factions within his own party and within his own cabinet, he found a winning combination by focusing on the true problems that faced our nation..

Sadly, Lincoln’sassassination cut short his own vision of reunification and delayed for too long the healing of the wounds caused by centuries of slavery. Reconstruction didnt successfully deal with the legacy of slavery and that legacy has haunted us since. We have made progress with overcoming those issues but we are not yet home.

This country is tormented by the problem of factions, which was recognized by our Founders in writing the Constitution. Factions was the Founders nomenclature for the problem of majoritarian politics. Those problems remain. Each of the existing parties wishes to establish a majority that must, if it follows the dictates of its own platform, scourge the minority. That is the continual political dilemma of a democratic republic. It is time to honestly recognize the problem and begin building a new consensus that can re-energize American idealism. Perhaps, the place to begin are theimmortal opening lines of Lincoln’saddress at Gettysburg.

Four score and seven years ago our fathers brought forth on this continent, a new nation, conceived in Liberty, and dedicated to the proposition that all men are created equal.

Now we are engaged in a great civil war, testing whether that nation, or any nation so conceived and so dedicated, can long endure.

Lincoln’s focus was on the equality of opportunity, not the equality of outcome. This campaign addresses outcomes, not opportunities. It does so with denials of fact and hysterical presentations. Hopefully, we can find the leadership to bring about a badly neededchange. Hysteria and denial are the Dragons Teeth of democratic government. It is time to stop cultivating these monsters.

Political Disaster as Opportunity

Nearly everyone familiar with American political history of the 19th century is aware that the Republican Party was founded in 1854, ran its first Presidential candidate in 1856 (John Fremont) and elected its first President, Abraham Lincoln, four years later.

Members of all political parties in the United States have accorded Lincoln a unique place in our countrys history. If Washington was our countrys first father, Lincoln has to be its second for saving the Union and opening the doors once again to a much-expanded vision of liberty and freedom for all inhabitants of this great land. While Lincoln fell tragically in1865, the Republic survived. A new breath of freedom issued forth as we struggled to wrest ourselves from the incubus of slavery and to use the benefits of strong economic growth to lift our people into an ever expanding cornucopia of economic progress.

Our progress, however, has not been a linear succession of triumphs. We have suffered many setbacks, but we have periodically leapt out of our dismal periods of seeming defeat to become a stronger and more abundant economy, a nation that has offered increased opportunities to all our people, and a beacon on the hill to many troubled peoples around the world.

Since those fateful years of Civil War, the American Republic has become a global leader, suffering much loss of blood and treasure in the process, in an effort to not only improve the livelihood of its own citizens, but also to offer a rays of hope to many enslaved masses whose strivings for liberty and freedom and opportunity have surged throughout the world. Those surges have repeatedly put immigrants on our doorstep. Immigration has a long, beneficial history in America even though some candidates now seem to revile it.

The recently concluded primary campaigns for Presidential nominations of both political parties have shown us to be angry and troubled, fearful over our future, no longer unified by the firm principles of our Founding Fathers or the great expositors of freedom and progress who have arisen to lead us from time to time. We are exhausted by the arguments and dispirited over the results. We are divided into balkanized factions, shouting our likes and dislikes, and largely intolerant of differing views as to our future. Unless one party sweeps the forthcoming fall elections, we are again likely to get a divided Congress. We may indeed face once more a Presidential succession that is bereft of a clear governing majority.

Some will see this an obstacle to a massive reform of the purposes and instruments of Federal governance. Others will see it as a margin of safety against relentless majoritarian and intolerant governance. If the electoral results do not produce a clean sweep, we will again be faced with a bitter political campaign two years hence. Such a campaign is likely to divide between policies that increasing the power of the majority to right alleged social wrongs, and broad based attempts to stop the avalanche of increased Federal interference in our lives, in the economy, and with our traditions of free choice and free expression. That is not a happy prospect.

It is now clear that the vital center of governance at the Federal level has collapsed, torn apart by extreme views on both the left and the right over the role of Government. Many will focus on the collapse in the Republican campaigns of the last two candidates to oppose Donald Trump. But we should not ignore the extreme left wing views of Bernie Sanders that won another state primary. Hillary Clinton may indeed become the Democratic nominee, but at this stage she hardly holds command over the hearts and minds of nominal Democrats or independents looking for a vehicle for their hopes and protection against their own fears. Trumps nomination campaign has already splintered nominal Republicans. Republicans are unsure of where their party is headed. Will Trump run from the Right of Clinton or from the Left. That depends upon the issue one uses to make a left-right comparison. Shades of 1860 once again.

Great political despair, however, can also produce a great political opportunity. The lack of central cohesion within both parties suggests an opportunity for a new party to emerge from the splintering of both traditional parties. This may provide a golden moment for coalescence around fairly clear values now widely held by thoughtful members of both existing political parties. Some will argue that a Third Party should now arise. We agree with that view, but we disagree on its timing. In our view, the best timing will emerge if and when Clinton wins the Presidency and perhaps the Democrats regain the Senate while the Republicans tenaciously hold the House.

Yet, even that outcome holds a threat since judicial appointments with no inhibitions to strong interventionism under a Clinton Presidency can change the character of our Supreme Court for more than a generation.

There could also be a growing coalition even within Democratic Senate to coalesce with some part of the House to find a common ground that will preserve our Union and preclude a massive move to overwhelming Federal power. Lets look at the issue agenda that a new party would have to address and from which a centrist bond must be forged. We focus on the following six issues.

Trade Policy; Taxation; Migration; Personal Liberty and Responsibility; National Defense and Budgetary Thoughtfulness.

Each of these arenas of contention contains a potential center. Each also needs national and local leadership to arrive at the center.

Trade policy: What dominates the extremes today is the pernicious notion that our trade agreements have resulted in unfairness. Contrary to populist opinion, growing international trade has been a net benefit to the American economy. Opening our borders has indeed created strong pressures to reduce some traditional manufacturing jobs. At the same time, it has created a wealth of opportunity for the more highly skilled and the more flexible in our work force. We need to encourage and reward those traits in our future labor force. As the global economy expands, there will be new soft spots in which other still extant manufacturing firms will want to move to take advantage of the expanded global supply chains that now exist. Some jobs will be lost, but some jobs in higher paying industries such as finance, technical services, programing, health care, etc., will grow. That is what a dynamic economy dictates. The key question is not whether growing international trade helps everyone, but how far expanded trade can improve our growth rate. We will return to this issue below

Taxation and Regulation: To supply the expanding fiscal needs that we have for various social services, (health, social security, education, environmental services), it is absolutely necessary to totally reform our tax system. We are punishing ourselves with a taxation system no one understands and depresses economic growth. It is a very simple issue. Growth comes from the bottom, not the top. Increased regulation is restraining new, small firms whose resources are not sufficiently large to cope with the hugely enlarged regulatory state we have erected since the end of World War II. What is necessary for expanded economic growth is to reduce, even abolish the corporate tax, and make it easier for new businesses to get started. Regulation and taxation, as we currently deploy them, are job killers and job movers. Large corporate mergers that take advantage of the economies of scale to lobby and to fight regulation are not job creators. They are job destroyers as they end duplicate jobs and services. Further, our global income taxation code insures that even more, large corporate firms will want to change their tax domicile. We have sowed the dragons teeth by allowing our corporate tax rates to rise relatively and absolutely as compared to other industrial nations. We are insuring ourselves lower corporate tax collections without incenting new business formation. In short, we are becoming our own worst enemies.

The resentment of growing inequality of wealth and income has put a hood over our political vision. We are getting the governance we deserve. The strong and large can fight, but the weak and small cannot be born and grow. We are in an endless cycle of job reduction and job movement overseas. It is an illness of our own making. We need to focus on improving economic growth and lessening the barriers to new business formation. To put it symptomatically: we need to stop hurting ourselves. If we are digging a hole out of which we are facing increasing difficulty to climb, we need to stop digging! Flatter taxation, replacing the corporate income with a lower, more efficient consumption tax, reducing the scope of rule making authority of our regulators and reducing the scope of ad hoc intervention in the economy are measures that will increase economic growth. An economy that is growing at 4% a year in real terms will generate far higher tax revenues. We can have a win-win growth and tax policy. Increase measures for growth and we will get more benefits from the growth we generate. Trade, better taxation systems and lowering the amount and extent of regulation and rule making authority can become a virtuous circle.

For those whose concerns are growing inequality, stop shooting yourself in the head and the foot. Move away from more mandates that increase costs to business and deter growth. Move away from arbitrary rule making that can confronted only by larger firms with large legal and lobbying staffs. Regulation is a prime source of slower growth and increased political corruption. We know there is a degree of correlation between the ease of doing business in a country and its rate of growth.1

Immigration: the false claims and rabid hysterics that have emerged in this primary campaign are shameful. First, some obvious points. Net immigration enhances growth. It is not a deterrent to growth. Second, net immigration is turning toward zero or maybe has now become negative. Three, immigrants are not the major source of welfare and health cost growth. That is simply baloney, as a quick look at the stats will tell you. Domestic safety and security are the first responsibility of the President. We need to protect our borders, but not bar entry to highly motivated individuals and families that wish to come here and work, invest, create new opportunities not only for them, but also for existing businesses. If there is one thing a new political party needs to implement, it is to create a secure, but not an impenetrable border. We need both skilled and unskilled workers to work in jobs that are difficult to fill with our existing work force. Instead, some zealots railing against income inequality want to raise minimum wages and make it even more difficult for young people to get jobs and job experience.

Environmentalism: Often by Executive Order, we are creating very difficult conditions for new business in the form of increased restrictions by the EPA and other environmentally empowered regulators. The caricature is the believers versus the deniers, of anthropomorphic sources of environmental degradation. Despite this Presidents claim, there are scientific questions yet unanswered. Unfortunately, our current President, has made the issue of Science in the argument over global warminga litmus test of over expanding regulation. Sadly, there are many scientific questions still to be answered. The argument that if we wait to do more, we will have more to do is a sophistry of the first order. If the President doesnt know this, he ought to. And his successors in the Democratic party ought to be wised-up as well Other countries who are vast sources of environmental degradation have to Walk the Walk not just Talk the Talk. If we are truly confronted with global warming caused by human agency, then we must understand the costs as well as the benefits for imposing severe restrictions on the US economy. Setting a good example for the rest of the world is not a costless demonstration project. Ranting that Science has proven its case is a complete distortion. The dialogue must shift to costs and benefits.

Personal Liberty and Responsibility: There are many false issues floating about this campaign, such as abortion rights, gay rights, gun laws, and the war against drugs. The common element is human behavior and whether there should be some limits on what residents in America can or cannot do. What is most evident in the campaigns on both side of the aisle is that Federal prescription dominates the field. The issues of abortion and gay rights have some common elements. One of them is our tax law. The question that any citizen should deal with is whether budget policy should fund abortion. Abortion rights are comingled with the issue of whether a woman should have the right to control her own body. But that is not where the rubber meets the road. It is over who pays for that right for those who do not have the income to pay for an abortion themselves. That is a question of externalities. What costs are imposed upon society by bearing children that might not otherwise be born if abortion costs are publicly subsidized One never hears that issue at all. Rather than spending fruitless hours on whether women have a right to abort a pregnancy, we need to shift the argument to the costs of unwanted children

The argument over gay rights is another question of equality under the law. The issue is very simply whether or not a family unit, under our tax and benefit laws, must be a man and a woman Why not just deal with the question of what constitutes a household for tax and benefit purposes and skip the unresolvable religious question of what marriage is or is not. Governments are not well prepared to treat philosophic or religious issues and the US has a long-standing prohibition for mixing up the two.

Gun laws involve another issue of rights. As they are now dealt with, fundamentally it is an issue of public safety versus constitutional rights. The science here is squelched. Everyone abhors mass shootings. They impose both personal and social costs. That seems to dictate a close connection between who uses weapons and under what conditions we can we demonstrate that the purchase of a gun and its misuse are intimately connected. The Government spends a lot on research for what may seem quite unusual investigations. The gun laws issue is loaded with statistics. We ought to be able to tell the true connection between purchased weapons and mass shootings from the data. Notice, we have focused on the so-called copy cat mass killings. Criminals usually dont buy guns so the real issue is public safety, particularly for our police. Furthermore, the issue of the existing stock of weapons is usually obscured. Without closing that loop, gun laws usually prove to be both inadequate and inadequately enforced. This is the time for clarity on what must be done to promote public safety and what the costs of doing just that may be.

Finally, we come to our drug laws and the continuing Governments war on drugs. One would think that given our history and experience with the prohibition of alcohol and the intimate connection to crime that Prohibition created could shed light on current policy. If we were truly focused on crime, we would change our drug policy entirely. Our war on drugs has created a very wealthy criminal class and the suborning of foreign country politicians. Narco States are direct consequences of our drug laws. Narco States pose geopolitical threats to our safety. The first step is to recognize what our current drug policy has created. It certainly has not restrained the use of drugs in the U.S.

National Defense: We live in a dangerous world. We have States equipped with growing nuclear prowess. This is a Federal problem to be surenot one to be dealt with separately by our 50 States. Second, we have non-State actors who threaten our safety. We have proven the efficacy of a volunteer army, but we need to insure that our military equipment is adequate and modern, sufficient to deal with small wars, and terrorism. With the smallest Navy since 1916, it seems that we are not providing sufficient equipment for our volunteer forces to cope with a very complex world. Further, the scope of global terrorism has expanded sufficiently to require much larger volunteer services (Army, Navy, Air Force, Coast Guard, and the intelligence support needed by these services). Since terrorism represents a global threat, we need to be in constant and direct communication with many countries, but we need to be perfectly clear to our allies concerning our willingness and capabilities to deal with threats. It does not seem prudent for the President to put public limits on the extent to which the Commander in Chief is willing to go to counteract terrorism anywhere in the World. Finally, once committed, our military commanders must be given the wherewithal to complete their mission. There is considerable controversy between the Parties and between their presumptive candidates. The public needs to know where these candidates stand on the use of force and the equipment needed to successfully deploy that force in our defense.

The Federal Budget: The Federal Government now consumes a substantial portion of overall economic activity. Promises made to potential political supporters grow exponentially with each election cycle. That is how voters are recruited. But all government budgets have inherent limitations. We can always prescribe a level of benefits and Federal activity that will exceed even the most expanded budget. There are always tradeoffs and the notion that expanding the Federal budget is good for the economy is simply another one of the chicken in every pot arguments that fail sound economics.

We are now well beyond the issue of whether we will have an expanded national health care systems or increased social security. The evidence is that the majority of the voting public wants both and wants more not less. There are only two courses: expand them to meet continually rising demands or begin a slow but steady process of replacing parts of each of these programs with privately funded mechanisms. There is no right answer, except real answers require total candor. Both Parties need to come clean. They need to tell it like it is. How much is required and who pays

When you listen to the debates, what you hear is invective and obscure funding mechanisms that fail to answer the question. It often revolves to some philosophic issue of what rights people possess. This is hypocrisy. Another fallacy is that the rich can pay for the poor, obscuring how an improperly instituted taxation system destroys growth and therefore limits Federal resources.

Fundamentally, we get a Government we cannot afford. It is time for some serious truth telling by our national politicians. Politicians win elections by promising voters benefits — even when the same politicians cannot clearly spell out who will pay and how much taxation will be required. The source of the problem is not the budget. The source of the problem is our electoral system that rewards a slice and dice approach to elections. The real solution is to change our electoral system, particularly at the Federal level.


When politics is no longer a way of life, no longer a permanent occupation with benefits determined by the current office holders, we will have cut the umbilical cord between promising more than we have and the continued electoral success of incumbents. We can argue about the extent of the term limits in the House and the Senate, but a rational approach might be one term in the Senate (6 years) and two terms in the House (four years). Cut off from using other peoples money, rational politics will be right around the corner.

Its time to turn the corner. Then, one can ask, what about the term of the President Maybe a single 6-year term would work there as well The existing parties and their enlarged political structures will surely tell us that term limits wont work because experienced hands will be needed at all times to prevent misguided legislation. Based upon the record that statement on its face must be false.

The Founding Fathers had a very different conception of politics–citizen legislators that had their own (other) occupation. They were right about a new birth of freedom. I think they were also right about citizen-politicians. We need to de-professionalize politics. Politics should not be a permanent occupation. Professional politicians have added only an expanding level of debt and an insufferably long debate about what to spend that debt on! They have produced little else for their voters. Its time to change the system. To do that, we will need a new party!







  1. See John Cochrane WSJ Growth Oped, The Grumpy Economist (johncochrane.blogspot.com) May 4, 2016. []

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 []

Judging the Risk of Future Black Swans: some policy implications

Economists and policy wonks are still intrigued by the events of 2007-8. The basic question is how to account for the fact that financial specialists extensively trained for judging risk got run-over by the collapse in the collateralized mortgage market. It has been well documented that the housing price run-up and its sudden stabilization was followed by a sudden and sharp collapse. This sequence displayed the same generic pattern of prior boom-bust price scenarios. One key to understanding such scenarios is that the process of leveling out in prices followed by a flattening is the precursor signal to a subsequent sharp fall in prices. It seems that the flattening period creates somewhat of a panic situation and, after a brief period of flat prices at the elevated level of the prior boom, huge doubts creep in. A rational investor will rush to sell these assets. When the music stops, it is time to quickly find an empty seat.

What kind of an expectation model underlies that kind of seemingly quixotic behavior A number of writers have produced models that seem to explain this behavior as a rational process produced by significant change in available information. A recent attempt is by a well known Professor of Finance who had an intimate connection as a consultant to one of the archetypal failure companies, (AIGFP).1 The critical element in the financial crisis is the collapse of the overnight repo market, whose collateral was often mortgage backed securities. Gorton and Ordoez have created a rational model of this regime shift by asset holders. First, these asset holders were believers in the underlying trend and as prices rise, they become more sure that they are on the right side of the market. Being long is rewarded at this stage. Being longer, can be even more rewarding. To purchase more of the collateral, asset holders borrow frequently overnight in the repo market. Their assets grow (both because of rising prices in a mark to market world create higher balance sheet values) but perhaps even more importantly, because access to the repo market creates seemingly unbounded opportunities to leverage their portfolios of what will become risky assets at a later stage. The essential question to ask is why asset holders allow their leverage to grow to such high levels Their behavior is not strange. The same behavior was observed in the underlying housing market. A borrower who watches his house rise quickly in value can easily sell the house and buy a bigger and better house by taking on a larger mortgage. Alternatively, new buyers, not previously accorded credit, find mortgages easy to obtain.

Where do the new mortgages generators come from They come from a pool of house buyers who previously couldnt qualify for a mortgage. But to create more qualified buyers, credit standards are reduced. As some writers on the crisis put it, as long as the buyer could fog a mirror held in front of his (her) mouth, they could get a mortgage. It was a self re-enforcing process. Another way to say this is that the leverage in the household sector rises sharply, and the same leverage expansion takes place in financial markets that deal in mortgages. At some point, the system begins to run out of fresh buyers and home prices begin to level out. That is a trigger to a sharp decline in housing prices and the decline triggers a fresh appraisal by collateral holders of the quality of their collateral. Haircuts rise on these derivative assets, creating a demand for cash collateral by financial intermediaries who have overly indulged on risk. The market begins to price risk much more sharply. Market players begin to think there is a black swan in their future. Housing markets never decline, right Wrong assumption!

Leverage is a two way street. In the beginning, increased leverage leads to high earnings on the same equity base. Earning increases by financial intermediaries are reflected in the share prices of these intermediaries. Intermediaries such as investment banks, commercial banks, and companies that provide shadow markets for this collateral seemingly benefit. Earnings for the financial sector have been rising, even in spite of modest interest rate increases. Finance becomes King of the Mountain.

The growth of the financial sector, in terms of the percentage of corporate profits, was one of the highlights of the first decade of this millenniumuntil the finance sector developed the major infarct of 2007- 8. Then the story shifted to one of Government rescuing the overindulgence in risk and the excessive leverage by large financials. We learned that rescue can occur in a somewhat indiscriminate fashion. Beneath those struggling financials was a long history of abnormally low interest rates, stimulated by the Feds fear of deflation and deficient corporate governance by each of the monitors of our corporate system.2

One particularly sad note in this history is the elevation of too big to fail, as national financial policy. Financials that significantly enlarged their assets were in fact being subsidized by the implicit rescue embedded in this too big to fail doctrine. Of course, if one listens to the politicians and the current government regulators, they will tell you that Dodd-Frank and its huge regulatory apparatus is designed to prevent another financial calamity. The government now says it will not underwrite financial firms that get into trouble through excessive leverage and ignoring the risks of future black swans. Do we really believe that another Lehman will occur We think that is nonsensical. What politician or regulator is willing to agree to a financial bigger than Lehman to fail the next time. This contention is a diversion from the real difficulties. Government produced the underlying drivers that led to 2007- 8. In particular, Government has never applied stringent liability standards that attach to the various corporate monitors supposedly acting in the interest of shareholders. There is no punishment to fit the crime when it comes to monitoring failure. That is a huge failure in political governance, and one not likely to be soon rectified.

Effective corporate governance depends upon transparent political governance. Given the lobbying done by large financial institutions and politicians continuing need for funding their electoral campaigns, what has evolved in the United States is a form of crony capitalism. That is precisely the opposite of what is needed, but that is another story that needs to be told. The first step is to realize that there are Black Swans (rare events that are not impossible) and that rare events do occur, often more frequently than we can foresee. Our focus must be on the incentives that poor policy often provides. To paraphrase a former President, its the economy [economic incentives], Stupid.

  1. See Gorton & Ordoez Collateral Crises AER Vol 104 Number 2 February 2014 and Gorton’s account of the collapse of the repo market in “Understanding Financial Crisis” (2012) []
  2. See our book Disorganized Crimes (2013) particularly Chapters 1-5. See also Chapters 6-15! []

The Shadow Drama of “Hold Up”

Todays story in the Wall Street Journal (Banks’Legal Bills Linked To Crisis Linger:Morgan Stanley, Bank of America Disclose Details of Continuing Regulatory and Legal Challenges) reported a settlement reached by Morgan Stanley with the Government of some $250 million. The settlement continues the gold mine of penalties exacted by the government from unwitting shareholders. Unwitting, because shareholders should have been protected to some extent by the Boards of the fined companies, had Directors truly acted in the interest of shareholders. Other victims of this government hold up strategy have included JP Morgan Chase (JPM), Bank of America (BAC), Goldman Sachs (GS) as well as many lesser lights in the mortgage debacle.

The strategy of reaching a settlement has paid big political dividends to the Obama regime seeking to show the public it is looking out for the publics interest (at least the 99%). To the extent that these awards reduce the deficit, one might argue that some merit attaches to the strategy. But, does it do anything about the future corporate behavior of the firms that are fined Probably not because the root issue is poor corporate governance.

As discussed extensively in our book Disorganized Crimes, shareholders pay the bill for these defalcations. In a bettered governed world, they would be protected by their Directors, at least partially. Largely, they are not.

Management has huge incentives to settle these issues outside the courthouse. Legal expenses pile up and testimony during the trial might further soil the corporate reputations of management. Furthermore, a constant attack by the Government hunting for corporate scalps takes management away from its primary duty to maximize the earnings of the corporation with due regard for safety. The Government knows that and can pound on the alleged malefactors while giving the public the sense that their interests are protected. It is a shadow drama. The wronged are the victims while the perpetrators get on with their business. True corporate governance reform goes by the wayside in the Governments take no prisoners campaign. Were it not so.

Corporate governance is deeply embedded and dependent upon our system of political governance

In our book Disorganized Crimes (Palgrave Macmillan 2013), we stress the importance of a political and legal system is for establishing a context (the nest) for proper corporate governance. Is it not ironic that the hammering of JPM over recent months, and the publication of an apparent settlement with the DoJ, (indicating a huge failure in corporate governance) has occurred at the same time as President Obama is foundering in his own governance crisis

There is a huge difference, however, between the formal structure of political governance and corporate governance. With our national political governance, the power of the Presidency is unrivaled and much can be done through Executive Order that would not pass our political systems checks and balances. This is best characterized by the famed Obama quote that Elections have consequences. I won. Uttered by the President in 2009, responding to a Republican stimulus proposal in a meeting with Republicans shortly after his smashing electoral victory in November 2008, the President ignored opposition suggestions. Obama is now ensnarled in an unending series of executive setbacks, mistakes and according to some, a continuing tissue of political lies.

The President has been forced to admit that his promise If you like your healthcare plan, you can keep it was wrong. Critics can and do now point to the hubris implicit in that campaign slogan. By- passing political and institutional checks and balances has consequences too! Isnt that reminiscent of journalistic claims of hubris and greed in our two recent eras of corporate misgovernance

Before running for President, Obama taught constitutional law at a leading American law school, but was apparently unfamiliar with the substance of his own signature legislative accomplishment. The latest faux pas for HealthCare.govis the delay for over a year in the mandatory enrollment date for businesses with less than 50 employees announced November 27, 2013 on top of other delays given earlier to individuals.

The growing list of Presidential stumbles began with the poor economic response to his 2009 Economic Stimulus package and his unwillingness to compromise with Republicans in the design of the tax reduction-expenditure mix they presented. It was at the meeting with Eric Cantor and his Congressional colleagues in 2009 that the Obama diktat cited above first emerged. Even after the election reversals in 2010 in which Republicans captured the House, the President pressed ahead with denials of responsibility for the killing of the US Ambassador to Libya in Benghazi; a threat to bomb Syria, quickly reversed when Congress objected; a re-opening of political dialogue with Iran and a subsequent agreement to give up tough economic sanctions in exchange for Iranian promises not to seek atomic weapons despite strong Congressional resistance to a weakening of sanctions without proof of Iranian compliance.

On the domestic front, the Presidents push on Obamacare (the ACA) has revealed a huge foul-up with multiple website failures and an apparent walk back on his promise that individual could keep their existing health insurance and their own doctors. It is interesting to compare this governance crisis with that of corporate governance failures. What are the essential points of difference

In Disorganized Crimes, we placed great emphasis on the effectiveness of an active and diligent Board of Directors for establishing and maintaining good corporate governance. All the other corporate monitors such as the auditors, credit rating agencies, outside general counsels as well as the full panoply of government and private regulators take their cue from the behavior of the board. The President has no board save the impeachment powers of the House of Representatives and trial by the Senate. The Cabinet and a coterie of Presidential advisors and staff are not the equivalent of an active board of directors. The President can listen to his advisors or he can disregard it, but he can easily fire advisors whose views conflict with his own. A corporate board can fire the CEO. A President can only be fired by an electorate voting once every four years. A President may be advised by his partys leaders, particularly those who must run for office in two years, but he can, if he so motivated, ignore their concerns. Presidents who are concerned with achieving a bi-partisan economic or foreign policy have often given significant time and consideration to the concerns of the opposing party. Beginning with a view that elections have consequences has created an environment conspicuous by its inattention to opposition views. Yet, listening to those who do not agree with a Presidents policy is a safeguard against greed and hubris.That is a self-imposed discipline. Some Presidents have have it. Others, simply know they are right!

Who’s Crying Now? The Shareholders—they always do!

In 2008, Jamie Dimon could do no wrong. At the drop of a hat (and a guarantee from the Fed of $29 billion, he took a dying Bear Stearns off the hands of the Fed-Treasury allowing the new Committee to Save the World, some breathing space. They didnt have much of a respite because by August-September the credit world was in shambles.

Dimon had snatched a plum from the Federal Money Tree even if he wound up having to pay the Bear Stearns shareholders $10/share ($8 more than then Treasury Secretary Paulson initially wished them to receive). The extra booty was not intentional. JPM lawyers had made a terrible mistake when they first signed onto to the shareholder misfortune train because they had already guaranteed Bears obligations for the next year. In for penny, in for a pound. JPM could have walked but the guarantees would remain. Continue reading