by MARIO RIZZO
It is said that when railways were first opened in Spain, peasants standing on the tracks were not [i]nfrequently run over; and that the blame fell on the engine-drivers for not stopping: rural experiences having yielded no conception of the momentum of a large mass moving at a high velocity.
The [above] incident is recalled to me on contemplating the ideas of the so-called “practical” politician, into whose mind there enters no thought of such a thing as political momentum, still less of a political momentum which, instead of diminishing or remaining constant, increases. The theory on which he daily proceeds is that the change caused by his measure will stop where he intends it to stop. He contemplates intently the things his act will achieve, but thinks little of the remoter issues of the movement his act sets up, and still less its collateral issues.
Herbert Spencer, “The Coming Slavery”
Quite a few years ago I gave a presidential address at a dinner meeting of the Society for the Development of Austrian Economics which was titled after Herbert Spencer’s 1884 article, “The Coming Slavery.” At that time I failed to understand the nature of an after-dinner talk and struck a too-somber tone for too long a time. Nevertheless, I have an enormous respect for Herbert Spencer and his analysis of the dynamics of government intervention in the economy and believe his observations are highly relevant to current events.
We are clearly on a slippery slope toward massive and ill-advised government interference in the market. Unlike many slippery slopes this one is not likely to take a long time.
Almost every day we hear: “We have already done this; why should we not do that?” Spencer called this is a “blank form of an inquiry.” Just fill in the relevant blanks for “this” and “that” and you get an argument of sorts.
The present financial meltdown which has its origins, I believe, in the monetary policy of the past decade that created the housing bubble is now the raison d’etre for many proposals to regulate, bailout, and subsidize. The particular reasons offered for each proposal will all share two words in common: systemic risk. Since the evidence of the extent of such risk and its consequences is uncertain, it has become quite easy to claim that the effects of any financial or business failure will drag us all down. But what is not well understood is how these attempts to save us may themselves also drag us down. Let me focus on two of the mechanisms of the slippery slope. For this I am indebted to work by Eugene Volokh and to a paper by Glen Whitman and me.
One of the most important of these mechanisms is the “cost-lowering” slippery slope. Once the $700 billion bailout fund for the Treasury was created it became cheaper for particular interests to lobby for their share of the pot. (After all, the pot is already there.) What was little noticed by the general public in the discussion of that legislation was that the Treasury was permitted to do much more than buy troubled assets with the $700 billion. More exactly, troubled assets were defined not only as mortgages or securities based on mortgages but any other financial instrument necessary to promote financial market stability. Buying preferred stock in exchange for capital infusion in any company is permitted. In fact, the original plan of buying mortgage-backed securities has been abandoned! Treasury Secretary Hank Paulson now sees financial stability needs in the sectors that provide auto loans, student loans and credit cards. Of course, the large industrial lenders like GE Capital and GMAC (financing part of General Motors) will probably be included when they reclassify themselves as banks or bank-holding companies.The next Administration has sent clear signals that financial stability requires saving declining manufacturing like the auto industry.
Cost-lowering slopes can be supplemented by “attitude-altering” slopes. This is what Spencer was referring to by “the blank form of an inquiry.” We have heard for weeks now that if Wall Street can be bailed out, then why not Main Street? The implication is, of course, that the first idea was a good one. Why else would the Congress and the president have approved it? (Poor argument.) And that the second idea is sufficiently similar in its economic impact. (Shall we invoke systemic risk again? Populism? Dime-store ethics? ) So now there is a proposal from the Bush Administration to have Fannie Mae and Freddie Mac alter the mortgage terms for homeowners in danger of default. But since only 20 perecent of so of the distressed mortgages are with these giants, the government is urging other mortgage lenders to change the terms. But can they alter the terms when the mortgages have been bundled and resold? Must these new investors approve? Clearly, this will be a legal nightmare. Any remaining obstacles to the impairment of the original contractual obligations may well fall.
Those of us who put stock in slippery slope arguments used to say that that the slope proceeds little-by-little – as if we were on a continuum. But now the steps are big, the sliding will be fast and the costs will be big. It is one thing to try to avoid a deflation by preventing the collapse of the monetary base; it is quite another thing to try to avoid the discipline of the market and the necessary reallocation of resources by insulating firms and individuals from losses. This is tantamount to trying to annul the market. It will not be successful but, in the meanwhile, we must worry about the consequences of the attempt. More to come I fear.