Inigo Montoya Moments in Economics

I just watched The Princess Bride again a couple of days ago. One of my favorite lines in the movie is when Inigo turns to Vizinni (after he said “Inconceivable!” for the bajillionth time) and says “You keep using this word. I do not think it means what you think it means.”

That’s what I thought of (while simultaneously being glad that I wasn’t drinking anything at the time) when I read the following (quoted in this post):

Similarly, the philosophy that playing the game of business and investment without rules (the technical term is Laissez-faire Capitalism) has driven our government since the election of Ronald Reagan, and went on steroids during the last two years of the Clinton administration and throughout the Bush administration.

Now, I don’t disagree that we’re now paying for stupid bipartisan policies going back at least as far as “the Gipper”. I also ought to mention that I think that some of the things the author of the referenced blog post has written about the current economic situation have been spot on. I just don’t think that anyone in their right mind, who has any clue about economics, could claim that the US has been operating under a “Laissez-Faire” system over the past two decades. Heck, I’m not sure there’s ever been even a single year when the US operated under such a system in its whole existence.

An economic system that actively intervenes in a “pro-business” or “pro-investment” manner is not the same as one that is Laissez-Faire. Not even close. In many ways, we have the very mercantilist/corparatist economics system that most of the “Laissez-Faire Capitalists” wrote against.

So, while there’s plenty of blame for the current collapse to be found in greedy businessman, clueless Wall Street chearleaders, and conservative politics, there are also plenty of blame for liberals, well-meaning progressives, and even many of the existing regulations that both exacerbated, and in some cases created a false sense of security that helped lead to this mess.

Blaming the current economic crisis on “laissez-faire capitalism” makes as much sense as blaming droughts on purple elephants in Greenland. The two have nothing to do with each other.

[Note: for all the space readers who are sick of my non-space posts, I’ll make sure I post at least two space posts before I venture another economics or politics post]

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Jonathan Goff

Jonathan Goff

President/CEO at Altius Space Machines
Jonathan Goff is a space technologist, inventor, and serial space entrepreneur who created the Selenian Boondocks blog. Jon was a co-founder of Masten Space Systems, and is the founder and CEO of Altius Space Machines, a space robotics startup in Broomfield, CO. His family includes his wife, Tiffany, and five boys: Jarom (deceased), Jonathan, James, Peter, and Andrew. Jon has a BS in Manufacturing Engineering (1999) and an MS in Mechanical Engineering (2007) from Brigham Young University, and served an LDS proselytizing mission in Olongapo, Philippines from 2000-2002.
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14 Responses to Inigo Montoya Moments in Economics

  1. Adam Greenwood says:

    Hannan said recently that you can’t borrow your way out of debt. I’d also add that you can’t regulate your way out of economic doldrums.

  2. Rand Simberg says:

    Funny that no one mentions the reason that AIG and the banks took such huge risks. Because of the moral hazard created by the knowledge that they were “too big to fail,” and they could count on the government to bail them out.

  3. Then there’s the point Arnold Kling has made several times, that the capital requirements imposed on banks for making normal loans was much, much higher than the capital requirements for making loans that got securitized. Basically the regulators were telling banks that they considered the odds of systematic risk to mortgage prices to be so low that they didn’t need to hold as much capital as they would for someone who put 20% down on a house and had a good steady job backing it.

    Among other things. This wasn’t a problem of lack of regulation.

    ~Jon

  4. Martijn Meijering says:

    “Basically the regulators were telling banks that they considered the odds of systematic risk to mortgage prices to be so low that they didn’t need to hold as much capital as they would for someone who put 20% down on a house and had a good steady job backing it.”

    And without the Fed distorting the financial markets with low interest rates for decades, it might even have been true, especially if the underlying loans were to people who had put down 20% and had good steady jobs. This was not only not a problem caused by a lack of regulation, it was a actually problem caused by (semi-)government intervention.

  5. Steve Bruns says:

    I think when you hear “laissez-faire capitalism” the author is referring to a general lack of oversight, and while they might be sloppy with their terms, that’s absolutely what brought this on. Greed (fed and fueled by bonuses to execs that rewarded them regardless of how they performed) encouraged riskier and riskier ventures (like the sub-prime mortgage debacle) and increasingly arcane money-making schemes (It’s beyond me why short-selling is legal. It’s predicated on trashing the markets, fer chrissakes!)

    And this is not merely a period of “economic doldrums.” These folks have brought the entire global economic system to the brink of collapse. In retrospect, it seems obvious that we should have a tight reign on an entity capable of wreaking this much havoc, but deregulation was a gospel preached by both sides of the aisle for many years.

    Wall Street reminds me nothing so much as a bunch of spoilled brats who cry “but we could have so much more fun it you’d just leave us alone!” Should we be the least bit surprised that now they’ve trashed the place?

  6. Jonathan Goff Jonathan Goff says:

    Steve,
    While agree that Wall Street leaders do share a decent chunk of the blame for this economic mess we’re in, and while I agree this mess is a very dangerous one…I think you’re making a big mistake if you overlook the political forces and well-intended but perverse-incentive-producing regulations that existed.

    The financial industry is already one of the most heavily regulated industries in the world. There are a few exceptions to the rules, but to act like the financial industry as a whole exists in some sort of “low oversight” environment is bogus. I think that while more regulation in some of the areas like Credit Default Swaps and Hedge Funds *might* reduce the odds of a repeat of this disaster, I doubt it will be a panacea. Regulatory arbitrage will *always* happen, and in case you didn’t notice, those Wall Street firms have the current administration by the balls. I have almost no faith that any regulation coming out of this will actually make the economy much safer, and am actually worried that in trying to fix the problem, that it will get broken even worse than it already is.

    Regulations may be able to block the old mistakes, but look at crap like Sarbanes Oxley and how much economic damage that has done to the country? Just adding regulations is *not* going to prevent the next time down.

    ~Jon

  7. Bob Steinke says:

    Let me play the devil’s advocate here. This post basically says that the financial meltdown happened in a pro-business interventionist climate which is very different from a laissez-faire business climate. The implication is that it’s not a counterexample to laissez-faire being a good system.

    My big question is whether there is any evidence to suggest that these companies would have behaved better under a laissez-faire system. For example, in John’s comment #3 he points out that regulations allowed banks to carry lower capital requirements for riskier loans than for traditional loans. This was a bad idea, no question. But look at the banks’ behavior. The banks carried the absolute minimum capital requirements that they could get away with. Are you arguing that if we adopted a laissez-faire system and eliminated all minimum capital requirements it would somehow cause banks to raise their capital reserves to responsible levels? Why? If they carry unresponsibly low capital reserves when regulations allow it, why wouldn’t they do the same thing when a liassez-faire system allows it?

    There are other problems like rating agencies with conflicts of interest making money by duping people about the true riskiness of various assets. Why should removing regulations prevent this from happening?

    I do understand Rand’s argument about moral hazard. Certainly, it’s possible that if government gives a wink and a nod and says, “don’t worry about risk” that could influence business behavior. It’s a possible cause. Is there any evidence that it was the actual root cause?

    It may be too soon for that kind of evidence. I would love to see Jared Diamond who wrote “Guns, Germs, and Steel” or Stephen Dubner and Steven Levitt who wrote “Freakanomics” dive into the data and produce root causes that can be supported by hard evidence. In the meanwhile, I get the feeling that there are a lot of conservatives who decide that moral hazard must have been the root cause because it’s the only thing compatible with their cherished pre-conceived beliefs.

  8. Habitat Hermit says:

    The US is not laissez-faire and I don’t think it ever has been either but is it now even capitalist? Sure the US is capitalist in the very weak sense of the word just like “state capitalism” or monopolies but how about the (normal) greater sense of the word signifying a system based on the general freedom of capital? Because right now it seems capital lost by a select group in the US by decree operates with fundamentally different properties than capital owned by people in general and that’s not really capitalism at all, just a very strange sort of cartel.

  9. HH,
    Exactly.

    Bob,
    Sorry I didn’t get back to you on this yet. We moved apartments this last week (a three-bedroom in our complex opened up for only a little more than we were paying for our old place, so we took it), and that took me out of the loop for a few days.

    Hard to explain my position (I’m an engineer not an economist), but let me give it a shot. A true lassez-faire system would look drastically different from what we have today. Just removing all regulations from our current system wouldn’t make it lassez-faire (and would probably screw things up royally–you have to remove the perverse incentives, moral hazards, etc, not just the regulations). In a true lassez-faire system, people would realize that Uncle Sam wasn’t protecting them on anything. There wouldn’t be FDIC insurance on deposits. There likely would be private deposit insurance, and that insurance would likely set up capital requirements. But it would probably be coming from at least a few different firms, who likely would have different and competing rules. It wouldn’t be perfect, but there’s a decent chance that it would’ve made things a bit more robust.

    Also, going back to the original discussion, we have several interventionist policies that also exacerbated things greatly (above and beyond the deposit requirements biasing people towards securitization). You also have things like the FED trying to hold interest rates artificially low (both during the run-up to the dot.com bubble, and during the current bubble). You have massive government-backed entities like Fannie and Freddie. You have the FDIC not collecting insurance premiums for several years. Previous bouts of massive inflation that helped kill the old-school style of mortgage finance and pushed things towards the securitized mess we currently have, etc.

    I guess my concern is that while markets do fail from time to time, and while there are greedy people on Wall Street (who did screw up royally this time around)…there are also greedy stupid people on Capitol Hill, most of who are owned part and parcel by Wall Street. There were regulations and other things that if stuck with could have made things better this time around. Sure, if we had a regulatory system made by and ran by perfect angelic beings, things would be great. But that isn’t the case. Government fails too. If regulations are put in place, they will be used for political ends for the benefit of the best connected companies and politicians. It’s happened before, and it will happen again.

    I have no faith in politicians to solve problems they helped create.

    ~Jon

  10. One major aspect of the financial meltdown and related issues is the general moral climate underlying society that has affected economics as well.

    As a people, Westerners (it isn’t just Americans) have never had such a large portion of its population be so shallow, self-involved, lacking in self-restraint and ethical grounding and engorged on an unearned sense of entitlement, as has been the case in recent decades. Couple that with a contempt for institutional memories that precede their own adult lifetimes (thanks to a continually degraded educational system), and the likelyhood that this societal component has reached critical mass, is it any wonder that we have our current debacle?

    Poor Alan Greenspan is supposed to have recently remarked that he couldn’t understand how business leaders would show such reckless disregard for their own interests. Poor fool, he thought these “leaders” actually cared about the businesses they headed. They don’t. A company folds, and these guys aren’t left holding the bag, but rather, they walk off with a big pile of loot. This is what we’ve come to: we are lead by looters in all walks of life — Congress, Wall Street, even entertainment and sports.

  11. Karl Hallowell says:

    Roderick, you seem to have forgotten all the other periods of Western history. There has never been a dearth of shallow, self-involved, etc people. Nor are there any periods remarkably different from today in the concentration of these sorts of people. In summary, I see absolutely nothing remarkable about the moral climate of today compared with any other period of human history.

  12. Karl,

    I beg to differ. I used the expression “critical mass” on purpose, and I am talking in the context of modern American history. In my supposision, within those parameters, I am correct. The moral climate is affecting the economy and politics. It plays directly into why our freedoms are eroding. It doesn’t take much to reach a “tipping point,” which is what we have done. Keep in mind that what I am calling “morality” is much more expansive than the trite, simplistic notion that that is something practiced by “religious” people — a notion that plays right into what I have observed about this broader moral climate.

    We live in an era in wich we are more loath than ever to enforce our own laws, show personal and group self restraint, take initiative, show courage and independence, opt for the difficult choices, etc. It’s a matter of degree rather than a stark, dramatic difference from the past. That matter of degree is part of the cause for the “tipping point.” This has been creeping up on us for three decades, and has arrived.

    With these new parameters, I suggest you take another look around.

  13. Bob Steinke says:

    Jon,

    First of all, congratulations on the new apartment. I’m sure you’ll enjoy the extra room.

    I think you’ve got a pretty grounded view about this. Certainly, any government action suffers from some inherent flaws. But I feel that choosing between regulation and a totally unregulated market is more of a pick-your-poison situation. Both have their flaws. And I tend to think the optimal mix includes some regulation.

    I’d like to make a point about your last sentence, “I have no faith in politicians to solve problems they helped create.” Are you implying that markets had absolutely no hand in creating this situation? If they were partly responsible, why should we have faith in markets to solve problems they helped create?

    I think Sarbanes-Oxley is a perfect example to illustrate a lot of the issues here. The original problem that Sarbanes-Oxley attempted to solve was that there were executives of companies who cooked the books for their own benefit at the expense of shareholders. Theoretically, this should not be possible. Shareholders vote for the board of directors who hire the CEO. The ability of the board to fire the CEO, and the ability of the shareholders to fire the board is supposed to keep everyone’s interests aligned. But how well does that really work?

    Let me put it another way. Congress should never do things that benefit special interests at the expense of the electorate as a whole because the elcetorate will fire them in the next election. How well does that work in practice? Not very well. By the same token I think the “checks and balances” of shareholders voting for the board of directors doesn’t work as well in practice as proponents of capitalism would claim.

    So there is a real problem. And this problem is inherent to the structure of the corporation. It is not imposed by outside interference. But in this case, when government tried to solve the problem they did a terrible job. They basically added a bunch of paperwork that didn’t solve the problem.

    Back to the Inigo Montoya theme, my biggest disagreement is with people who think it is “inconceivable” that there could be any problem whose root cause is inherent to markets. Every problem with markets must be caused by outside interference. I don’t think government is a perfect solution, but I don’t think markets are a perfect solution either. So pick your poison.

    You also made another point that I like. What you call a lassez-faire system is not just about removing government, but also about building up structures like private deposit insurance. I would put this under the heading of civil society. I think things like social norms have more influence on markets than people realize. Think about Roderick’s comment that Greenspan thought that these corporate leaders actually cared about the businesses they ran.

    I think a strong civil society could perform the funtions that we now rely on government regulations for, and it could do a better job. For example, if we had a better whistleblower culture where employees would sound the alarm when a CEO is doing things bad for shareholders. Or if shareholders saw keeping track of the actions of the CEO and board as more of a moral duty akin to voting in political elections. And of course, we could have private deposit insurance, private building codes, private product safety certification, etc. But those private firms could be easily subverted if their only motive was profit. They would need to have an ethical component of their mission as well.

    But I wouldn’t call this the same as a laissez-faire anything goes market. And I don’t think these things will automatically spring into existance if we remove government. I think we need to first build a strong civil society where people are expected to play fair, and not just do whatever they can get away with. And where people’s vulnerabilities are protected by social institutions, which might not be governmental. Then, as civil society builds this capability we can start dismantling government.

  14. Harvey Kendall says:

    Great article…and love how you managed to tie it into the Princess Bride!

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