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. Oleg says:

    What we need is a different way to rank politicians. There is a software tool for fighting vandalism on Wikipedia, where anyone can come in and make any edit to pretty much any article. The tool works by assigning reputations to editors, and the reputation is based on how long their edit survives. Edits that add value tend to remain, while bad ones get replaced quickly.

    We should do the same for politicians: rate them on how long the measures that they propose and vote for survive. If this rating gets widely accepted, politicians would carefully consider their actions and aim for long-term effects.

    This is a purely tongue-in-cheek suggestion, but they say in every joke there is a grain of truth.

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  2. J says:

    I think you have to admit part of the reason why political incentives are focused on the short term results is because the people that elect them also have a short term focus. Most of the anger people are venting about is how to fix these problems, and fix them now. If we put a politician in office for the next 10 years and he/she made a plan to work out the situation in that time frame, and things were worse five years out… it wouldn’t matter what the laws was; that person would be dragged out into the streets.

    The problem is everyone has a different threshold for “the short-term”, and it’s incredibly difficult to have people determine, even for themselves, the difference between what they want and what they need.

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  3. Gary says:

    I can solve two of the three incentives (money, reelection, ego):

    1. Stop funding individual politicians and fund the election process. This separates the lobbyists from those whose votes they buy. When donor/lobbyists fund the process, all certified candidates are financed equally (certification needs to be figured out, but it’s not unresolvable) . The best at managing their allotment and message probably will win and what we need are good managers. Donor/lobbyists get some influence but it’s diluted. This idea doesn’t require public funding, either.

    2. Term limits. Plain and simple – you can’t make politics a career because your interests are narrow while the public’s are broad.

    3. As for ego. Well, just maybe if the first two ideas work, politics won’t attract so many narcisistic jerks.

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  4. David Leppik says:

    I don’t think it’s a matter of having a better political system. The fundamental question is who gets the short end of the stick. At some point, certain voters will be winners and certain voters will be losers. The only thing an ideal democratic process could accomplish is to provide that there will be more winners than losers…

    …and that’s assuming that the winners get to vote. In both Greece and the US, the crisis was caused when voters were getting huge value by borrowing unsustainably, and the winners were “us, then” and the losers are “us, now.”

    That said, we’re far from a perfect democratic process, given that the main winners have been the 1%, and continue to be.

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  5. Eric M. Jones. says:

    When FDR faced the last depression, he saw that the problem was that people (except the rich) had no wealth and no income. So he created a variety of programs like the CCC, WPA, AAA to inject wealth back into circulation. Of course the Republicans, then as now, were utterly opposed to it. FDR taxed the wealthy heavily (94%!) to support the social programs.

    http://en.wikipedia.org/wiki/Franklin_D._Roosevelt#First_term.2C_1933.E2.80.931937

    After WWII, the top marginal tax rate declined through successive administrations to the point where the government now BORROWS its operating capital from the rich.

    High marginal tax rates are not bad. Remember that deductions were the means used to get the rich to invest instead of spend on luxuries.

    Of course, the Democrats, then as now, were utterly confused, but FDR kicked butt, took up the challenge and vilified the rich to get the job done. Too bad President “No Drama” Obama is such a nice guy in a time when serious ass-kicking and arm-twisting is needed.

    I see no short-term hope.

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  6. Becky says:

    It’s the PEOPLE who elect the politicians who are the problem. As long as THEY are more interested in short-term gain, or getting “benefits” that they didn’t pay for. . . they will keep electing politicians who give them what they want.

    If you hit your thumb with a hammer, do you blame the hammer?

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  7. Basil White says:

    How small do we need to make government before banks stop collecting insurance claims on writing their own bad mortgage loans and bailing the loans out with taxpayer money?

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  8. Thomas says:

    Some observations from Europe: The US has unfortunately a 2 party system. Imagine a commodity with only 2 suppliers.
    Democrats & Republicans have settled in the left and right corners and don’t face any competition there. If you are left you vote Democrats, if you are conservative yo uvote republicans. It’s not a free market…

    Well-loved. Like or Dislike: Thumb up 6 Thumb down 1