Learning and Bureaucracy

The market is an evolutionary process, in which selection forces actors to learn, and price conveys the information necessary for that learning. The pressure on the individual to innovate (or face losses) is not a pressure applied strictly to firm owners and managers- it is also applied to workers and job-seekers.

The Iraqi band Acrassicauda recently acquired refugee status and settled into a nice New Jersey metal band lifestyle. One of them explained their prior training and conditioning:

“We’re good at process,” said Mr. Riyadh, 24, who has previously used the name Marwan Hussain. “Going to the U.N.H.C.R.,” he said, referring to the United Nations High Commissioner for Refugees, “standing in a queue for three or four hours. We’re good at that. But musically, we need to practice.”

This reminded me of what Irina Pantaeva said of her training in Soviet Russia:

Neither of us knew how the fashion business worked in the West. That models carry thick books full of glossy pictures, and that they made appointments and worked with agents. We knew only what we had learned in Russia: if you want something, go to where it is and be prepared to wait.

In a bureaucratic country or system, there is no pressure applied that can force the individual to work, learn, innovate, or generally train themselves. Instead, they learn to wait on lines, fill out paperwork, and ask others for handouts. Expect a lot more of this kind of learning as government continues to rapidly grow, and a lot less innovation and new technology.

Mortgage Socialization

Cross-posted at Heritage.

Fannie Mae and Freddie Mac were created during the New Deal by the Roosevelt administration in order increase home ownership. With government backing and price controls, the supply of housing was artificially increased, with the funds coming from the taxpayer.

Even when Fannie and Freddie were made into government sponsored enterprises (GSEs) in the 1960s, they were still provided the financial support of the Federal Government. Because of their implicit government guarantees, these policy-based suppliers came to dominate the housing market.

As GSEs, Fannie and Freddie purchased 44% of subprime mortgage securities and were the biggest buyer of Countrywide loans. They became an industry duopoly, owning or guaranteeing about half the $12 trillion mortgage market. Risk was socialized, spread across all taxpayers through government guarantee, while profit was concentrated and private. This is a prototype case of government thriving on “concentrated benefits and dispersed costs.”

The ability to do this is what drives government expansion, taking from the masses and channeling the money to a minority – or special – interest. With these special interests, campaigns were launched, politicians entrenched and bureaucracy expanded. Hence Fannie and Freddie represent a massive rent seeking operation, to funnel money into the hands of officials at the expense of the taxpayer.

And yet none of this was sustainable, because it wasn’t profitable. Inevitably there would be collapse. Fannie and Freddie engaged in Enron-style accounting, and mafia-like corporatist tactics. It was their privileged status that led to the corruption, and that distorted the housing market and helped to inflate the housing bubble (also made possible by loose monetary policy).

The government takeover only makes all of these things worse. In the short run there is relief that a market collapse won’t occur imminently, but like the Soviet Union during perestroika, the fear of pain during reform can only lead to the delay of collapse and a more painful landing. Further concentration can only cause further waste, as competition, profit guidance and valuable price signals give way to bureaucracy, rent-seeking, inflation and misdirected investment.

As nationalized firms, Fannie and Freddie are government agencies, relying entirely on public funding. They have no reason to keep costs low, and every reason to allow short-term political objectives to guide their choices instead. Indeed, the Treasury has made it very clear that they will specifically move away from profit guidance. Treasury secretary Paulson said on Sunday that the entities “will no longer be managed with a strategy to maximize common shareholder returns.”

Paulson has promised that the fees they charge banks for loan securitization services will be examined “with an eye toward mortgage affordability,” even as they are neck deep in bankruptcy. This reminds me, again, of the logic of perestroika – instead of freeing prices up and allowing some market adjustment, so that the economy could finally get on track, a compromise was made. Prices would be “based on social costs,” companies were allowed to “take into consideration cost-effectiveness” but “speculative price increases aimed at excessive profit” were forbidden.

The logic of the expanding U.S. government is becoming just as warped. The socialization of risk caused the housing crisis, and the response is to nationalize. Risky lending driven by policy not profit caused the collapse and the “reforms” will reduce fees and shun profitability. If we keep moving in this direction, we’ll pass through our own reverse perestroika, and end up a socialist state.

Rent-Seeking and The Housing Crisis

Recently, a scandal has broken out that provides great insight into the housing crisis. Countrywide Mortgage brokers have been treating Congress to VIP lending rates. Accepting donations of $100 or more is illegal for these politicians, but scandals like this are not uncommon. The deeper question is why a profit-seeking business like Countrywide would want to offer discount rates to government officials in the first place. It is, of course, because they expect something in return.

If government could not offer these businesses any preferential legislation, exemptions from taxes or relief from anti-business regulations, there would be no incentive to buy them off.

Economists call this kind of activity rent-seeking. When firms spend money – or decrease their profit – in order to ensure favorable treatment by government it is not efficient. They produce no more output, and instead the resources are wasted. The favorable treatment gives them a monopoly position or an advantage over their competitors and the consumer suffers.

It also encourages government officials to pass more kinds of regulations that strangle business so that there are more chances to offer relief in exchange for pay-offs from the businesses. So, it creates a feedback loop leading to more regulations, more bribes and then even more regulation.

The only way to end the cycle is to limit the scope of government with a clear line preventing government from offering any kind of preferential treatment to firms.

But rather than moving toward a smaller scope of government, we are currently headed in the opposite direction. The new housing bill is set to bail out firms on a preferential basis – often by helping those, like Countrywide, who made the most risky sub-prime loans. In the future, these businesses will remember the compassion of Congress and will take these risks again.

Local governments will benefit too – with $3.9 billion in community development block grants. These grants are provided so that local governments can purchase, renovate and resell foreclosed homes. The proceeds can then be used to do this again next time that government subsidies followed by government bailouts lead to a new round of foreclosures. In this way, government can cause a crisis, solve it, and cause a new one, little by little expanding its scope in the process.

Have we not learned the lessons of the National Recovery Administration, when subsidies and bailouts, public works programs, and stringent regulations led us to a consolidation of government and big business that strangled private initiative and threatened the liberties we hold dear? Apparently we have not – a recent Time Magazine poll showed that 82% favor public works projects and 70% say more government programs are needed for those struggling.

The more that we allow government to solve our economic woes, the more that it expands its scope and creates new woes, just to have something more to solve. This is the rent-seeking power of government at its most frightening.

Cross-posted at the Heritage blog.

Note that the Center for American Progress was very enthusiastic about the community development block grants - HT Econlog for that.

Competition and Anarchy

Over at Distributed Republic, Micha Ghertner argues the competitive government position for libertarianism/anarchy:

I personally would much rather take the risk of letting isolated communities victimize their own members than the opposite risk of adopting a social rule whereby those with sufficient political power are free to "reproduce their ideologies and prejudices" upon all members of society, and not just a few sub-communities within it.

Many people tend to take a moral stance on anarchism: a democratic state should set the social rules, otherwise the strongest will brutalize - mobsters will take over and nobody will be safe. But, what if government currently is the mob boss? On the one hand, democracy is supposed to prevent that, but we all know that tyranny of the majority can oppress the minority (Hitler was democratically elected) so this argument is weak at best.

On the other hand, you have the idolization of the state as moral authority, which makes it dangerous. While the miniature states (or private security firms) can also take on this superior moral role, at least there would be more competition and free entry and exit from the states, so that minorities can easily escape persecution. Potentially they would also be less idolized if they were voluntary and competing.

Could this be a consequentialist morality argument for anarchy - that our values are more likely to be protected in a system with competition over moral authority?

Update: coincidentally, Arnold Kling just posted something on the same subject.