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Financial Reform: The good, the bad, and the smugly

Address Symptom or Transform System?

by Fred E. Foldvary

On the table for financial reform are some useful plates and cups, but we need to beware of not setting dirty dishes. How can we differentiate?

The key to financial reform that enhances both liberty and prosperity is simply to prohibit coercive harm, while allowing any activity that does not directly harm others. That is the rule of the universal ethic.

Fraud needs to be prohibited, which implies willing and knowing parties. Each party to a transaction should either be informed that the contract may have hidden costs, or else all the known facts should be plainly disclosed. The judicial branch of the government should facilitate bankruptcy for companies that fail. But arbitrary "bright lines" such as limiting particular types of transactions should be avoided.

We have seen with the recent Ponzi schemes that governmental regulation and institutions such as the Securities and Exchange Commission cannot be relied on to keep transactions honest. SEC employees were reported to be viewing pornography on the job while the financial world was crashing down. Years of warning about fraudulent financial schemes went unheeded.

The ability to sue for damages is the foundation of contract enforcement and the avoidance of fraud and harm. Contractors should be informed whether there is sufficient insurance to provide this remedy. If anyone is to be bailed out, it should be the victims of a fraudulent institution, not the failed institution itself.

Some economists propose ending the use of the U.S. dollar as the international reserve currency. That would reduce the borrowing power of the U.S. government and also of U.S. companies. That is an example of treating a symptom, rather than the cause. Being able to borrow funds is not a problem. The problem occurs when the borrowed funds are used to purchase subsidized asserts such as land, which then fuels a speculative bubble. If we reduce the power to borrow, we also reduce the power to invest and thereby create greater growth and prosperity.

Other economists seek to abolish banks and replace them with mutual funds that would avoid risky loans. Again, this treats the effect rather than the cause. Even if all loans to buy land value are made only by mutual funds, this will not eliminate the boom-bust cycle. Mutual fund chiefs would no more understand the real estate cycle than bankers.

A finance professor proposes that a federal board should be established to investigate when a financial institution fails. But their findings would be as superficial as his suggestion, since there is no such thing as a truly independent government board. They tend to be captured by the regulated industry, and their findings would be as smugly superficial as are many of the reform proposals.

Critics of the financial system are now bleating "market failure." They cry that "the efficient market hypothesis" does not work. They bark that "markets are not self-correcting."

If markets do not self-correct, firms would not fail and go out of business. Unlike government, failed firms collapse, and the share prices plunge to zero. But only a truly free market is efficient. We have had mixed economies with governmental interventions that distort prices and profits. The biggest intervention is the implicit subsidy to land value caused by providing public goods paid for by taxes on labor, trade, and capital goods rather than on the rent generated by these services. None of the market critics are proposing an efficiency tax shift. Instead of market failure, we have market-critic failure!

There is a very deep global cultural bias in favor of authority and against freedom. Most of the thought about social issues is superficial. Even most scholars do not understand the ethical foundation of a free market, and they do not understand the dynamics of free markets.

They will not admit it, but most people are police-state socialists. They seek to impose tyranny on peaceful and honest human action. Police-state socialism claims to protect the public from problems such as financial crashes, but instead favor the very subsidies that create the boom-bust cycle, the taxes and restrictions that create poverty, the controls that stifle freedom, and the governance structure that promotes privileges to the powerful interests.

Henry George provided the ultimate remedy: think for yourself. But that implies a willingness to confront one’s most deeply held cultural biases.

This article first appeared in the Progress Report, www.progress.org. Reprinted with permission.

Dr. Fred Foldvary teaches economics at Santa Clara University and is the author of several books: The Soul of Liberty, Public Goods and Private Communities, and the Dictionary of Free-Market Economics.

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Comments

I suspect that land is as much an effect as a cause for bubbles. Excess income might also have something to do with it, given the fact that most bubbles follow changes to tax rates on capital gains, income or dividend income for the very richest.

Taking care of land value won't suddenly end the power of wealth over workers. Ted Turner did not control CNN because he bought Montana. He bought Montana because he controlled CNN and used the proceeds to buy up other channels. He got rich because he could extract economic rent from his workers because he had managerial location rather than geographic location. He made the deals which allowed him to pick workers that he wanted and pay them what he wanted without there having as much freedom to find equivalent employment elsewhere (since the labor market was not entirely free, but instead oligopsonistic).

Ted's politics was liberal but his management style certainly was not. Had it been, he would not have become fabulously wealthy - instead everyone in the network would have become somewhat more wealthy but no one plutocratically so. Indeed, if ownership of the network were cooperative, rather than plutocratic, Montana would be owned by other people and CNN would have no outside shareholders and its employees would not use outside finance for personal use. No employee would go outside the cooperative for a home loan and liar loans would be impossible. There would have been no boom.

# posted at by Michael Bindner

If cooperatives held the land of their employees in trust and provided all social services to their members, there would be no need for anything like Georgism. Cooperatives in need of more land would buy it. If cooperatives made sensible site location decisions, there would be no question of land value unless they tried to locate in the same general vicinity. The more inward cooperatives are, however, the less likely they will compete for space since their main capital will be human, not land. Instead of going where the people are, they will bring the people to them.

# posted at by Michael Bindner

I invite readers to look at my take on this issue, which is on my Free For All blog.

I would not simply regulate financial markets or work with land values, I would use cooperative establishment to eliminate financial and stock markets. Anything else is a half-way measure which will leave the state in place.

# posted at by Michael Bindner