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Pulitzer-Winning Palaver

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Tags Financial MarketsFree MarketsInterventionism

04/03/2012James E. Miller

Back at the height of the financial crisis, Steven Pearlstein of the Washington Post wrote a number of contradictory columns both praising the bank bailout known as TARP while issuing a scathing criticism on how the big banks were using taxpayer funds to pay shareholders and executive bonuses rather than lend credit. According to Pearlstein, those ignorant folks wary of Uncle Sam padding the balance sheets of reckless bankers (emboldened by the housing policies of the federal government, its mortgage-based GSEs, and the cheap money of Alan Greenspan's Federal Reserve) virtually free of charge just didn't "get it."

Apparently those who regard the virtue of private gains and losses as a fundamental necessity for markets to work efficiently are just too dense to comment on these matters. The world was imploding (or so we were assured by a banking class desperate to keep the party going, as well as its alumni occupying positions of authority within the Federal Reserve System and US Treasury) so there was no time for critical analysis. Taxpayers should have kept their claps shut and let their elected officials shove more squandered funds at an already-zombified banking system.

To really bolster the merit of his opinion, Pearlstein cited his own Pulitzer Prize in an online chat with Washington Post readers as proof of his superior knowledge on such a serious affair.

Nobody has been more critical of the practices of banks and Wall Street and brokers than I have, probably long before you were even focused on this issue, so I certainly don't owe you any apology on that one. If you want to check, you'll see I won a certain prize for that.

Who knew the Pulitzer Prize gave you free reign to declare any opinions contrary to yours null and void?

Recently, Pearlstein used his column to comment on Greg's Smith controversial New York Times editorial "Why I am Leaving Goldman Sachs." Smith's editorial caused quite a stir among the financial commentariat where everyone and their grandmother has weighed in on its significance and reasoning. While those knowledgeable on the mutually satisfying nature of a free economy were critical of Smith's attack of Goldman, many reveled on accusations of unfettered greed dominating the industry. Pearlstein falls in the latter camp, as he regards Smith's piece as wholly demonstrative of the evil exuberance of the infamous vampire squid.

The predictable response from Wall Street was to dismiss Smith as hopelessly hypocritical and naïve — hypocritical because he didn't resign from Goldman until after he had been passed over for promotion and after he received his 2011 bonus check, naïve for thinking that trading financial instruments with customers has ever been anything but a zero-sum game.

Such a dismissal would be more convincing, however, if it wasn't merely the latest piece of evidence of the ethical deterioration at Goldman in particular, and on Wall Street more generally.

As it happens, just as Greg Smith was reminding us of how Wall Street rips off its customers, Washington was moving to roll back regulations designed to protect investors from that kind of predation.

So begins Pearlstein's tirade on the opposition of banking regulations. The rationale for financial regulations falls back on the Marxist ideology that holds that capitalism is a system of exploitation where clueless consumers and workers fall prey to cash-rich producers. Because Joe Schmo happened to take out a loan he couldn't really afford to pay back, nanny-state bureaucrats have no other choice but to step in and protect him against his own choices. But of course no one forced Joe to take out a loan or patronize a bank; he does so on his own accord and believes himself better off in taking the money. Presuming anything else grants far too much insight to the observers who believe themselves all-knowing of any individual's unique preferences. It's sort of like the central banker who attempts to dictate the proper interest rate for millions in lieu of a rate determined solely by the time preferences and spending habits of all market actors.

If Smith's, as well as Pearlstein's, assertions were true and Goldman really was ripping off its customers en masse, then simple market forces would put it out of business fairly quickly. As John Tamny observed,

Indeed, what must be stressed here is that Goldman couldn't purposefully do badly by its clients even if it tried; the firmwide ethos of "putting clients first" the tautological mantra of any business — irrespective of sector — that wants to remain in business for the long haul. It couldn't because if it did, so great is the competition for its client list that it would soon find itself a hollow shadow of its former self.

For being a well-regarded business columnist, Pearlstein somehow misses the fact that only consumers believing themselves to be benefited by the services or goods offered by a company determine said company's success. Going off this naïve understanding, Pearlstein begins defending financial regulation.

What we also know from painful experience — from the mortgage and credit bubble, from Enron, Worldcom and the tech and telecom bubble, from the savings-and-loan crisis and the junk bond scandal and generations of penny-stock scandals — is that financial markets are incapable of self-regulation.

This would actually be a very good passage if it were just tweaked a bit to include the real cause of all the crises listed. It should read like this:

What we also know from painful experience — from the mortgage and credit bubble, from Enron, Worldcom and the tech and telecom bubble, from the savings-and-loan crisis and the junk bond scandal, and generations of penny-stock scandals — is that the Federal Reserve's low-interest-rates policies perpetuate the continuance of asset bubbles.

Pearlstein's argument would hold up if the financial industry were indeed void of any government regulation. The fact is however that for almost a century, the Federal Reserve has been in charge of regulating the industry. Prior to the Fed's inception, regulation at the state level was prevalent. Contrary to Pearlstein's belief, the financial industry in the United States hasn't operated under laissez-faire conditions in well over 150 years.

Financial markets are hotbeds of asymmetric information, when one party in a transaction knows much more about the thing being traded than the other.

Again, for an expert business columnist, Pearlstein comes off as uniformed on how markets really work. There is hardly an industry out there where the same amount of information is held by all market participants. The essence of entrepreneurship is superior forecasting skills — that is, being more knowledgeable and in tune to consumer demands than competitors. If Pearlstein is going to charge the financial industry with being unfair in the lack of evenly dispersed market information, he has to be critical of all sectors of the economy to stay consistent.

Financial markets are magnets for moral hazard, where people can take risks knowing that they won't have to suffer the full consequences of those decisions because of government bailouts or insurance.

Thankfully Pearlstein recognizes the role of moral hazard in perpetuating risky behavior. But his recommended cure is just more of the same disease already distorting the checks on exuberance that would exist without government interference. With the existence of the Federal Reserve, the Federal Deposit Insurance Corporation, sanctioned fractional-reserve lending, and Congress's history of doing what it does best and throwing money at perceived emergencies, why wouldn't Wall Street overly leverage itself if its losses are expected to be socialized? Surprisingly, Pearlstein recognizes this dynamic:

And financial markets are highly conducive to herd behavior because bankers and money managers know that, no matter how disastrous their decisions turn out to be, they won't lose their jobs or their standing in the industry if they were making the same bad decisions as everyone else.

Despite all this, Pearlstein still sees further regulation as necessary to curb the excesses of Wall Street. This shortsightedness doesn't account for the role bureaucratic red tape plays in benefiting large firms such as Goldman Sachs by making it more costly for small startups to establish themselves and pose as any sort of competition. Pearlstein asks, "Have you ever met an executive who said he liked regulation?" Well, Steve, considering the Federal Reserve was the product of scheming bankers, one of the largest private health-insurance-industry lobbying firms (AHIP) endorsed Obamacare, and the CEO of Walmart, the country's biggest employer, called for raising the federal minimum wage just a few years ago, then yes, I have heard of the heads of big business actually liking regulation.

The real question to ask is if it's really that inconceivable that big business is more than willing to get behind regulation if it poses a financial burden on its competitors. Considering that the nature of the state is to grow in size and authority as it seizes ever more control over the private lives of its citizenry, any savvy businessman would see the advantage of co-opting such power for his own benefit.

Pearlstein ends by digging into the JOBS (Jumpstart Our Business Startups Act) bill that recently passed the House of Representatives. This bill would

exempt any firm with less than $1 billion in sales from many of the reforms enacted after Enron or the latest financial scandals.

Under the House-passed bill, these "small" companies would be exempted from rules requiring that they disclose the compensation of executives and other insiders or that they give shareholders the right to approve such compensation. They also would be exempted from having to hire outside auditors to assure that they have internal controls sufficient to prevent and uncover investor fraud.

Again, Pearlstein invokes the image of clueless investors incapable of making sound decisions on whom they place their money with. From a private-property-rights perspective, it should always be up to the owners of a company to disclose whatever relevant information they see fit. The same applies to government decrees forcing the hiring of outside auditors. Certainly these measures would improve the image of a company seeking private investment. But investors who choose to devote their scarce capital to a business venture do so because they anticipate that they will derive some benefit from it — either a monetary profit or some other desired end. If a small startup business lacks compensation disclosure or outside auditing, that is a risk any voluntary investor is free to take.

Despite all of his accolades, Steve Pearlstein fails to understand how a free market uninhibited by government regulation would function. He pokes fun at the laissez-faire views of those who don't see markets as zero-sum contests between exploiters and saps, while he also accuses firms like Goldman Sachs of conning their clients who voluntarily invest their own money and bear the inherent risk that exists when doing business with such firms. With opinions like this still permeating the editorial sections of the nation's most-read newspapers, it shouldn't come as a surprise that much of the public still believes them.

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