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?


vinita

Read Hind Swaraj for what Mahatma Gandhi had to say on this.

Shane

Yet we are seeing some pretty severe austerity budgets in various countries. So this suggests that an alarmed electorate can be persuaded to make sacrifices if they feel it is in the country's interest.

Here in Ireland the main party who was in power before and during the crisis began austerity budgets and was destroyed in the general election, but the parties who replaced them were also promising severe budget cuts and tax hikes. There have been no riots and only a few minor protests, because most people think that this is necessary. So long as the governing parties can convince people that sacrifices are necessary, people will give them a mandate to make risky but necessary cuts.

So I wouldn't give up on the political system just yet! Estonia is another interesting example, pushing through an austerity budget of 9% in 2009. They seem to have bounced back well, growing 8.4% in the second quarter of 2011.

(I'm not saying that austerity budgets are necessarily the smartest way to deal with things. But perhaps it shows that governments can take unpopular measures, and have widespread support, if they convince the public that it is necessary.)

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Oleg

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.

J

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.

Gary

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.

David Leppik

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.

Eric M. Jones.

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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Becky

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?

Basil White

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?

Thomas

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...

Jason

There is a lot of support for term limits here, and I was in agreement until I moved to California. Our term limits have created an Assembly full of two types - 1) Neophytes with minimal understanding of process or negotiation; 2) Idealogues with no incentive to break their promises in order to get something done. (Most are both.) This seems to point to two alternatives.

One is a strong party system. There are parliamentary systems where a few people make all of the decisions and everyone else falls in line. There are also "smoke-filled room" systems, which is what California had under Willie Brown. Different structure, same result. Stuff gets done, but not too democratic.

The other is what Kim proposes above - actually competitive districts. Not sure how to make this happen in an era where we have so much information that allows us to predict how people will vote - do we just gerrymander until every district is 50/50? If every district were competitive, would it lessen the amount of money available - harder to finance hundreds of races instead of just a targeted few?

Not sure how to make it happen, but hopefully we can make progress in that direction soon!

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Travis

I think you should consider working with Lawrence Lessig on the whole issue of politic and incentives. Or at least thinking about his recent work.

Todd Batt

What's not to love about this idea right?

It sounds like a snide remark, but until we find someone that has the personal magnetism like a Reagan, Kennedy, Clinton or Obama to shepherd ideas from candidates like.. Paul, Cain, McCain etc (pick your fave)... it's going to be very very hard to sell the swallowing of the jagged pill that will be necessary to recalibrate the switch from short term focus to longer term. Someone to sell the idea that maybe it isn't wise to retro-fit an economy to facilitate everyone owning a 5k sq ft house as an economic litmus test of success.

At some point, someone tells you that you need to lose weight through hard work and you decide to go through the pain. Nobody likes to admit that that tipping point is a decision normally made very superficially, but it you think about it.. we all do it. We are waiting for a person to rally around. When they have crazy hair and don't stay calm (regardless of the real content of their idea)... we discount them. Ron Paul, Howard Dean, Rick Perry whoever...

And with the idea attached as well. It's going to take one prominent person to usher in a change like that for congress.

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Andy Daly

I could not agree more with this, however longer terms are not the answer. Any faith in politicians working with all of the public's best interests at hear has been seriously eroded on a number of fronts (fundamentally in the UK by the expenses and phone hacking scandals). Despite the rhetoric of "we know what is like for the average person" most do not have clue - take one leading MP recently whose wife stated in a national paper that £130 was a "reasonable price" for a haircut.
We need a solution that genuinely looks at the best interests of all, not merely the 23% of the voting population it takes in the UK to get you into power. A system that relies on research and evidence based improvement and policy development rather than populist recycled rhetoric by individuals with no specialist expertise or in depth understanding of the field they fumbling with.
I would potentially suggest a system that does not have a ruling party but voters would elect representatives proportionally and then these independent representatives would have to work collaboratively to agree policy cross party.

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DaveyNC

I realize that this is tantamount to heresy, but here is what should have happened on that day back in 2007 when Bernanke and Paulson went to the President to brief him. Bush should have:

1. Summoned the CEO's of the various problem banks; Goldman, Wachovia, Bank of America and so on, to a meeting in his office. He should have instructed them to bring a box of their letterhead.

2. He should have had each of them dictate their resignation letters and then sign them.

3. He should have then announced the issues that had developed and that the US would backstop all of the problem banks and begin to unwind the mess, as was done with AIG. In other words, take them over. Don't bail them out, just backstop them in case of collapse. Enforce an orderly dissolution. Break them up and wind them down.

4. Summoned Paulson to his office and demanded his resignation, since much of this happened on his watch at Goldman.

This would have made sure that some damn body paid for this mess, if only in the loss of their jobs and prestige and would have reassured the markets that the US would not allow a disorderly collapse. This would still have taken years to unwind, but maybe we could have avoided this death by a thousand cuts that we are enduring now.

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