"When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals.
We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues"

( JM Keynes, "Economic Possibilities for our Granchildren" 1930 )

Thursday, December 31, 2009

Should Financial Rescue be "Fair"?

It is almost unanimously agreed that the economic crisis and subsequent bailouts were the dominant topics during 2009. The “rise and fall “message delivered by the establishment is the “we saved the world” mantra, supposedly reflected in the rebound of capital markets values since March. This discourse generally focuses on aggregate economic terms and tends to play down the fairness aspects of the measures taken during the crisis.

Professor Brad De Long (Professor of Economics at the University of California at Berkeley) deals directly with the fairness aspect: Prof. De Long believes that the multi trillions USD financial rescue of the banking system was necessary albeit unfair to many other sectors. Let’s see a quote from his article:
The Fairness of Financial Rescue

This response ( EF : the support the prices of risky financial assets) is understandably controversial, because it rewards those who bet on risky assets, many of whom accepted risk with open eyes and bear some responsibility for causing the crisis. But an effective rescue cannot be done any other way. A policy that leaves owners of risky financial assets impoverished is a policy that shuts down dynamism in the real economy”.


I would like to deal with the fairness aspects from many angles, so I will focus on a few terms to explain my point.

Risky Assets: It seems that there is a misunderstanding of the moral foundations of market Capitalism when the “impoverishment of the owners of risky asset” is considered as a bad idea. According to the financial theory, the essence of a risky asset is that its holding entails a possibility to lose (or earn) money. If the system guarantees beforehand that an asset owner would never lose money on an asset (or asset class) then risk disappears and the asset becomes “safe”.

The relation between risk and reward is a cornerstone of the market system. The market ideology considers the extraction of earnings by the asset owners class as a fair compensation for the risk the entrepreneur bears when it invests his capital in a risky project. However, if under a “new paradigm” the system guarantees that the investor will not be impoverished whatever happens, where is the risk to be compensated for ?Why should asset owners benefit from earnings? Isn´t such a position undermining the foundation of the market system?

Dynamism: Prof. thinks that the unfair allocation of means to ensure the wealth of asset owners is a necessary bad to guarantee the dynamism of the system. Well, almost 70 years ago the Austrian economist Schumpeter coined the term “Destructive Innovation” to describe the innovative entry by entrepreneurs which is the force that sustains long-term economic growth, even as it destroyed the value of established companies. Therefore, according to that (widely accepted) view there is nothing really bad in impoverishing asset owners. Moreover, that is precisely the economic mechanism that ensures the growth and prosperity! Is the Professor proposing to eliminate that mechanism?

Fairness: Any social structure relies upon its particular terms of fairness, justice and morality. Even the most ruthless tyrannies, supposedly ruling with high doses of coercion, devote large efforts for propaganda and persuasion. If a major issue like the bailout of the banking system is admittedly solved in an unfair mode (rewards… many of whom …. bear some responsibility for causing the crisis…) why should people common people support a system that exacerbates the unfairness? However, were all the possible efforts made to try and minimize the unfairness related to the bailout? Beyond economics, doesn´t the professor understand that the alternative for a common perception of decent fairness and justice is a society based only upon crude power and coercion?

I will end this post with some open questions: Is the division between effectiveness and fairness rather artificial for social and economic systems? Isn´t “fairness” an essential component of the effectiveness of policies in a Democratic society? In other words, when we say “effective”, effective for whom?

*Professor of Economics at the University of California at Berkeley and a Research Associate at the National Bureau of Economic Research., former Deputy Assistant Secretary of the Treasury under Summers- Clinton)

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