Why Does the Worldwide Financial Crisis Fester So?

In today’s Journal, David Wessel nails it. (If you ask me, Wessel nails it consistently.) First, he asks the question that needs to be asked:

It has been two years since the flames were first spotted in Greece, yet the blaze still hasn’t been put out. Now it has spread to Italy.

It’s been five years since the U.S. housing bubble burst. Housing remains among the biggest reasons the U.S. economy is doing so poorly.

On both continents, there is no longer any doubt about the severity of the threat or the urgent need for better policies. Yet the players seem spectacularly unable to act.

What’s taking so long?

And then he offers a compelling answer:

Deciding who will get stuck with the tab.

“In every crisis, you have to allocate the losses between debtors, creditors and taxpayers,” says Anna Gelpern, an American University law professor and former Treasury official. “It’s a shockingly simple concept, and completely intractable.”

“By definition, it’s a political problem,” she adds. “Even if you came up with an optimal allocation, if it’s not politically salable, it can’t happen.”

Most people agree by now that our political structures are too incapable and/or impotent to a) responsibly address a crisis of this nature; and b) help create a framework that would prevent future crises.

To my mind, much of the trouble lies in how politicians’ incentives are badly misaligned: they are rewarded for short-term, self-interested activities (raising money, getting re-elected, coming down on the right side of short-term public opinion) while the goals the public really wants accomplished are long-term, public-interest works (which have almost nothing to do with raising money, electing politicians, or getting a good headline).

I have some inchoate ideas for how to address this incentive gap — to be framed out and written about here someday, hopefully — but I’m wondering what you all think of this politician-incentive problem and possible solutions to it?

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  1. Al says:

    I have been saying this for more than 5 years. Politicians are in politics for themselves and the people who give them money. Short term fixes to get re-elected.

    It is all a shame, however, if you read Howard Zinn’s ‘A Peoples History’ you will see the system is actually working pretty much how the forefathers wanted it to be.

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    • Mike B says:

      You forget that voters by and large WANT easy answers. It’s been mocked and satirized for decades. Europe has dealt with some of this by having a political class that is less accountable to voters, but that tends to only work when it comes to paying for long term investments. Also, back when media was more monolithic it was possible for the leadership class to sell sacrifice as an easy answer…but today there are a hundred pundits ready to jump on board with an even easier answer. This will only end once the public is ready to acknowledge reality.

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  2. John King says:

    It is only part of the problem, albeit a large part. The “intractable” factor is that losses are necessary and we are watching politicians who absolutely refuse to consider alternatives to the current Keynesian scheme. They do it because it offers what they believe will mete out the least pain as well as save their own hides. They lack the courage to attempt alternative solutions – tax cuts and government austerity – even though history shows these have worked. The current policy only prolongs the pain over protracted periods and will end in tears anyway while risking hyperinflation, war or both.

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    • Owen says:

      What historical examples are you referring to?

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      • Douglas Turner says:

        Hidden due to low comment rating. Click here to see.

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      • Michael says:

        Maybe not everyone is as well read as you. Can you condescend to supply some examples? It is the internet so a copy-pasting should be all you need to do. Thanks, looking forward to it.

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  3. Leo Godin says:

    Since most in Congress are career politicians, they are always in campaign mode. That mode may ramp up or down depending on how close elections are, but they are always campaigning. I’d like to see eight year terms for the Senate, House, and Presidency, but limit eligibility to one term. I would also prevent anyone currently in Congress from running for President. This would have two main benefits.
    1) Once in office, they’d have eight years without campaigning. They could focus more on their legacy–which is more likely to result in public good–than their campaigns.
    2) With eight years in office, they’d be able to look at a 3-5 year plan and not be so concerned with public and donors opinions today.

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    • KL says:

      I like that idea and believe that the underlining principle, the fact that politicians campaign frequently, contributes to the short-sighted nature, especially in the House. However, by lengthening the time of service, you could also be decreasing the functionality of politicians, which is to represent their constituents. In an 8-year term, there is less incentive for politicians to stick to campaign promises during the first few years of the terms since voter memories are also short-sighted. This leaves only the latter part of the term as effective governing.

      I believe the solution may be capping number of terms in office at 2 (as we have with the presidency). This should place more incentive for politicians to focus on their legacy (which tends to have more of a long-term outlook on their performance) then their re-election.

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      • KL says:

        Alternatively, the government could issue financial options to politicians, similar to the stock options offered by companies. If a politician choose to partake in this program, he/she could purchase an option for a fixed price and the option would have an exercisable date years in the future. The value of the option would be determined by the sum total of GDP increase/decrease from the time the option is granted to the time the option is exercised. This would tie in the politicians’ financial objectives with that of the country’s.

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    • Ryan says:

      Let’s go with 6 years for President and Senate, staggered 3 apart so things don’t change all at once, and random selection every 2 years for the House, where one has to opt-in to the pool, which requires possessing a high school diploma or equivalent and passing a citizenship exam.

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    • Owen says:

      I disagree with term limits. To support them I would want to see hard evidence that term limited politicians are more effective than their alternatives. I don’t think this is true (but I’m not sure).

      I see two primary reasons for getting rid of term limits.

      1) The people most affected by term limits are good politicians. In order to believe in democracy one has to believe that with all other factors being the same (money, influence, etc) a bad politician will lose more often than a good one. That means the most likely candidates (with all other factors being the same) will be the ones most often reach term limits. The quick argument against this is that all other factors are not the same. I would agree but the solution is not to limit who can run for a position. It is to address the other factors, like how much money can be spent.

      2) The most productive politicians are experienced ones. Like any job, experience pays dividends. It is fundamental to the process that the politicians are around each other often enough to get to know one another and learn how to cooperate.

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      • Douglas Turner says:

        I would tend to agree with #2, except it seems to be the experienced politicians causing the problems. I think maybe we need the clueless about how Washington or [Fill in your states capitol].

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      • Enter your name... says:

        Also, term limits don’t result in career politicians getting a real job: they result in them running for a different office. So two terms in the California Assembly, two terms in the state senate, and then your choice of returning to the Assembly, running for the US House, or getting a state-wide office in the executive branch.

        So if the idea is “get rid of career politicians”, it’s a predictably hopeless failure. All we’re doing is making sure that the unelected office staff know far more about the job than the politician. (“Yes, Minister”, anyone?)

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    • uthor says:

      I like the idea, but see two problems with it. The first is that there’s a political machine in place and it takes some time to learn the ropes. With a one term limit, you are left with hundreds of congressmen who don’t know hwo to go about getting things done for a significant portionof their term.

      The second problem is that you have no record be which to judge a person by when it comes time to vote. Related to that, you have little option of removing someone who doesn’t work out as hoped. The two year term of someone in the House allows for the public to have control and judgement over how their representative acts.

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  4. David Collins says:

    While the political will to effect such a change is missing, the first two problems could be fixed (at least significantly reduced) by public campaign financing (with spending limits) and term limits for all political offices.

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  5. 164 says:

    My answer is that markets are out of equilibrium because prices freely move up, but are “sticky” on the way down. In other words property prices have come down a little, but not enough; wages have fallen a little but not enough to reflect market forces.

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  6. Wake Up says:

    Hidden due to low comment rating. Click here to see.

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    • Joshua Northey says:

      I like Ron Paul, spoken to him once or twice, and he makes a lot of good points. But a limited government isn’t the solution to all these problems. A better government is. I agree under the current system simply reducing the size of the government may be the best course of action, but there are a lot of important roles for the government in a well functioning society. I think fundamentalist libertarians tend to be a little naive about that.

      Government should absolutely be regulating pollution, enforcing robust zoning codes, making edicts about what people can and cannot eat. That is how you solve a lot of important collective action problems. But right now the government is a such a slave to two completely ineffectual parties that it is probably better to just reduce its power as much as possible.

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      • John B says:

        Did any of the people voting positive read what this person wrote? Government should absolutely be:

        ” enforcing robust zoning codes, making edicts about what people can and cannot eat. ”

        1. Robust zoning codes have caused much of the real estate problem, prevented buidling reasonably priced housing, racial segregation and created suburban sprawl. And helped NIMBY’s become NIMBY’s.

        2. The government should make edicts telling us what we can and cannot eat? To put it mildly, one of the least intelligent posts ever put on Freakonomics.

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    • caleb b says:

      I’ve always found it interesting that one political party thinks that government is horrible at choosing what wars to fight and how to combat terrorism, but can be great a deciding how to distribute tax dollars with health care and retirement. The other party thinks the government is terrible at distributing tax dollars for Health and SS, but great at choosing what wars to fight.

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      • twobeef says:

        I think your use of the word “great” is misplaced. One group of people believes that government should exist as an enforcer and little more. These people think that we should continue to have a powerful military and continually be a major part of foreign affairs, but that all other matters should be left up to the market. Despite the various externalities and market failures of private business, they find it easier to say that government is just inefficient at everything. It makes a better bumper sticker.

        Another group of people thinks that government should be a sort of defender of the people, that the government exists to fill in the gaps where private business fails. So they tend to ignore any of the gains to national wealth or invention brought on by major corporations and paint any CEO as a creature of evil. It’s less about what they actually believe and more that you just ignore and forget certain things when you need it to fit a narrative.

        But then, it’s really not about one political party or the other. President Obama told people on his way into office that he was going to add more troops to Afghanistan and would invade Pakistan to kill bin Laden if he was found there, and many registered Democrats supported him on that. For all the grumbling about inefficient government health care, I would be willing to be that most Republicans want social security and medicare to continue as they are because there’s more risk in dealing with private healthcare and investments. This is a war about words, not about actual ideologies.

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  7. Joe in Jersey says:

    Like many other things the solution lies in aligning the incentives of the politicians with what is good for the country. However is that really possible in that politicians have such short term concerns. Would the solution be to increase term length, but stagger the elections so that they still occur at the current pace. Still creating the proper incentives isn’t easy even when you thought it would be, look at CEO incentives and what a disaster that has been.

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  8. Jack says:

    Agree with the comments on term limits, and extending the length of terms — though disagree on how many terms and overall length. The downside of a single 8 year term is how to fire those doing a poor job, and how to “reward” those doing a good job.

    Additionally, a balanced budget amendment and a cap on federal budget growth (except in times of war/emergency) indexed to inflation (or something else meaningful) would force politicians to make hard decisions of allocation rather than just borrow more money or kick the can down the road.

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    • Nate says:

      Perhaps with a long length of term to kick out the those doing a poor job have a yes/no vote after four years on whether to continue or face a reelection but with a necessary yes vote at say 40%, obviously there is some incentive to cater to short term goals but it is reduced compared to the current system. The good guys should be able to get on with their jobs while only the atrociously bad should face the risk of being kicked out.

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    • Joshua Northey says:

      You don’t need longer terms to help enforce longer time horizons if you simply make it impossible to ever serve a second time. It removes all the pernicious effects of angling for re-election. Of course you do then always have a group of neophytes.

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    • Leo Godin says:

      I thought about that as well. But since most presidents win re-election and most in Congress serve several terms, I figured that being able to fire them is almost irrelevant now. As far as rewarding the good ones, I thought about that as well. What if a tradition started for each member of Congress to take on a protege? If someone does a good job, and people like what they’ve done, they’ll elect that person’s protege. It’s not the typical reward, but it’s something.

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