Posner, Part 1: Two Conceptions of Blame

A few readers have asked us for our thoughts on Richard Posner’s recent writings on the economic crisis, beginning with his new book and continuing with his epic blogging for The Atlantic. (To read his account from the beginning you need to find the well-hidden Archives section in the right-hand sidebar of the blog.) The challenge is that every time I try to catch up Posner has written another couple of thousand words. So I’m going to have to do this in pieces.

Posner is a giant of legal scholarship and in the theoretical branch of law and economics, which (judging from my own education) is the dominant paradigm for several fields of law, including torts and contracts. To simplify his importance greatly, he helped shift the legal profession, including both the academy and the courts, from a focus on justice – law should redress the harm suffered by the victim – to a focus on incentives – law should create incentives that will produce the greatest good for society in the future. For example, in general, firms should only be held liable for injuries they negligently cause if the expected total damages they cause exceed the cost of preventing those injuries; if we require firms to conduct inspections whose cost exceeds the cost of the injuries that those inspections would prevent, then we are reducing aggregate utility.

As you might guess, Posner is also generally a pragmatic conservative, who thinks that free markets usually lead to better societal outcomes than government intervention, and that public policy should focus on making sure that independent rational actors have the right incentives to behave in ways that will benefit society as a whole. Not surprisingly, his account of the crisis focuses not on the actions of people in the financial industry but on the failings of people in government.

From his May 5 post:

The government has conveyed to business and the public the message, which misunderstands the causes of the economic crisis, that “Wall Street” should be blamed (or China too, as Geithner once suggested) and must be punished. This hostility and air of menace make financial firms reluctant to get into or stay in bed with the government, and thus impede the bailout efforts. . . . In fact the major culprits in our present economic distress are government officials, such as Alan Greenspan, and academic economists, but they are getting off lightly, because they are obscure and there is more political mileage in denouncing “Wall Street.” How many Americans actually know who Alan Greenspan is, or what a macroeconomist is?

Now, I have also written that if you want to blame one person, then Alan Greenspan is your guy – because, of all the people who could have helped prevent or mitigate the crisis, he was the most important. But I also think that “Wall Street” – or various actors in the financial sector – should be blamed.

There are two different senses of “blame,” and Posner – true to his decades of scholarship – focuses only on one. His approach to law and policy is thoroughly utilitarian. The question you always ask, reading his opinions, is what incentives this decision will create for firms and individuals, and how their behavior will change in the future. Moral blameworthiness does not enter the equation. For example, Posner is a famous proponent of the “efficient breach:” the idea that if you find a better use for your goods than honoring a contract, you should breach the contract, as long as you are prepared to pay damages to the party you have injured. According to Posner, this maximizes social utility (measured in dollars and cents). (Incidentally, not all legal scholars agree – it depends on how your measure transaction costs.)

Posner does not care about moral blameworthiness; insofar as fault is concerned, he only cares about causation. And from that standpoint, no individual Wall Street executive is a necessary part of the chain of causation that produced the crisis; if he had walked away in disgust, someone else would have taken his place and done the exact same thing. (Greenspan, by contrast, could have changed things, had he so chosen.)

From that standpoint, if you want to focus on how the system should change in the future, it makes sense to look at what government can do and not at what individuals in the financial sector should do. If mortgage brokers cut corners and investment banks marketed toxic securities and rating agencies gave AAA ratings to those securities, they are not to blame; it’s the fault of the legislators who didn’t make those activities illegal and the regulators who didn’t enforce the rules that did exist.

But that is an unsatisfying, academic, and patronizing concept of blame.

Take the mortgage broker who steered his client into a subprime mortgage when the client could have qualified for a prime mortgage (because the subprime mortgage paid a higher commission), thereby saddling him with interest payments the broker knew he couldnt’ afford; or the bankers who sold small towns in Wisconsin synthetic CDOs without making sure the customers knew what they were buying (but covered themselves by shipping hundreds of pages of unreadable disclosures). From a pragmatic perspective, there’s nothing you can do about people like that; they exist, they will do whatever they can within the rules to make money, and the only answer is to tighten the rules.

But from a common sense, everyday perspective, of course they are to blame. They were making money for themselves by hurting other people, and they knew it. There’s nothing wrong with President Obama criticizing them. And if there’s a way to punish them – legally, and to an extent proportionate to their culpability – we should do it. If the only way to punish them is to drag them before Congressional committees and make them endure the spotlight, then that’s fine by me.

But, Posner says, “This hostility and air of menace make financial firms reluctant to get into or stay in bed with the government, and thus impede the bailout efforts.”

There are two answers to that claim. First, it assumes that we need the financial firms we have now, in the form they are in now, with the directors and officers they have now, and therefore we have to plead with them to let the government bail them out. This is an unnecessary assumption. Unfortunately, it is one that seems to be shared by the current administration.

Second, and more importantly, it amounts to coddling bullies. The implicit principle is that whenever a major institution does something wrong – but not illegal – we have to overlook it, because we are more dependent on that institution than it is on us. Actually, the principle would still apply even in the case of illegal behavior. Let’s say a large bank had done something illegal. They would still be too big to fail, we would still have to bail them out, Posner would still oppose a government takeover – “because of the manifest inability of the government to manage banks competently” – and so we would still have to make nice, for fear of scaring away the banks we depend on.

If I wanted to take the economistic approach, I could say something about moral hazard at this point. But I don’t want to take that path. The idea that people can commit egregious misdeeds at the expense of other people, yet cannot be criticized by our own government – the body that is supposed to represent our interests – violates a simple, common sense notion of justice. At least the one that I hold.

By James Kwak

70 thoughts on “Posner, Part 1: Two Conceptions of Blame

  1. What a wonderful analysis! I now start EVERY day by reading Paul Krugman’s blog and this one. Someone once said that after Plato’s Republic, all subsequent philosophy is but a footnote. Krugman, Johnson and Kwak are doing similar good from a journalistic standpoint today. As I move from their web sites to the NYT, WSJ and the political blogs each day, I find I can skip over more and more subjects because my favorite analysts have always done such a good job of sketching the larger picture before hand.
    As for other traditional media–CNBC, my Des Moines Register and so forth–forget about it!

  2. It strikes me that a utilitarian non-moralistic approach to economics works for a long time, but not forever. This goes to the idea of a rationalist approach to economics versus one that involves the emotional reactions people inevitably bring to economic decision making. In the end, as more and more people reach the same conclusion James has reached here (I have spoken with many others in the same position recently), the bottom-line variable that has clearly been affected is trust. Behind every transaction at all levels of our economy is trust. With that severely damaged, we are supposed to just move forward and forget how these people screwed us over? I don’t think so.

  3. Obviously, we have to now expect greed from the players. I blame Greenspan for three reasons: Low rates for too long, encouraging alternative financing options in 2004, and most importantly, believing these guys would “self-regulate” because it was in their best interest to do so.
    Wrong, wrong, wrong.

    But the bigger culprits, for me, are still in the picture How are these inept legislators still in office? Our legislators failed miserably on the regulation front. From discrediting Brooksley Born to failing to rein in Freddie and Fannie.

    As Elizabeth Warren has pointed out, the fabric meant to protect the taxpayer/consumer was systematically dismantled thread by thread.

  4. Posner has been wrong fro years. His analysis now is no different. Accountability is a fundamental concept that spans millenniums and allows for the functioning of societies, governments and economies.

    Under his analysis only one participant is accountable. Nonsense.

    If the individual behaved in the way he thinks companies / business people behave there would be chaos.

  5. Boris, trust is a quality that is created when people hew to an established social order with set rules. In our social order, “fairness” and “honesty” are important constituent parts. What the Chicago boys with their non-moralistic approaches have taught us, is that we NEED morals. Without a moral framework, there can be no trust. Without trust, there can be no lending. Without lending, our entire system collapses under the weight of its own “on-time delivery / short term operating capital loan” necessities (which aren’t really necessary, just convenient, but that’s a topic for another day). Ironically, the thing this economic catastrophe teaches us about Capitalism is the same thing that the collapse of the State Economy behind the Iron Curtain taught us about Communism: without honest, honorable brokers and fair, evenly observed rules, NO financial system can function effectively. The more that the banksters have stacked the deck, the faster they have brought about the collapse of the very system they are profiting from.

  6. It’s interesting that, at least in this instance (I haven’t followed Posner’s blog so I don’t know if this is true across the board), he doesn’t seem to follow his own logic to its proper conclusion. It’s incoherent to say malefactors will violate to the extent the government allows them, so anything they do is the government’s fault, and then stop there.

    No, if you’re being logical, you would take the obvious next step and say that in a 1st world nominal democracy, anything the government (and by extension powerful interests) does is allowed by the people and is therefore the people’s fault.

    You would say that in a democracy by definition anything, any crime, is ultimately the people’s crime, and they have only themselves to blame. Does Posner (or other anti-government “conservatives”) have the courage to say this? Or is the argument just a pretext, just anti-regulatory advocacy dressed up in the alleged dignity of jurisprudential-economic philosophy?

    They may say it’s the government’s job to regulate, and if it fails to do so there’s no one but the government to blame. But regulation, like anything else, does not exist in a political vacuum. Effective regulation doesn’t come from an ivory tower where economic philosophers calmly calculate “efficiencies”. It comes only in a favorable political environment (just as the effective deregulation of the 90s and 00s came in the favorable environment where everyone was led to believe in the infinitude of stock and housing bubbles and globalization, where financialization cadres would appear on magazine covers trumpeted as the torch bearers of civilization). Part of what generates this environment is public moral perceptions, including the effects of the bully pulpit.

    So to say public opinion leaders should muzzle themselves because they’re being unfair to morally blame economic wrongdoers when the blame should accrue to the government which failed to exercise its regulatory responsibilities (BTW, isn’t Posner’s own accusation of this alleged “unfairness” itself implicitly a moral objection?) is de facto to argue vs. regulation itself, since this would deny an essential nutrient to the regulatory process.

    So the whole thing is just another anti-government, anti-regulation, anti-public gambit, but dressed up as a sophisticated, objective philosophical argument.

  7. I have put myself in the cubicle of said mortgage broker and while I would have been fired for not getting enough ‘good’ business, I could see how one would see the bonuses & attaboys the workers on either side. Seeing that the dilemma is stay there and toe the line, or find something else. I doubt there were many options for someone who would have been in that business at that time. That is why I believe so strongly in regulation. All it takes is one bad actor to start a race to the bottom.

  8. This is one of those really helpful analyses that steps back from the leaves and looks the whole tree, including the roots. Thank you.

  9. I’d also like to second James’ point that Posner’s argument assumes (1) Too Big To Fail in itself, (2) that we “need” TBTF for some reason, (3) that it’s practically necessary to have TBTF and keep feeding this monster, that we should now live in perpetuity under the thumb of a gutter protection racket, (4) that this is morally right. (As I alluded to in my comment above, whenever someone argues that it’s wrong to inject morality into a discussion, almost without exception that’s because he is implicitly upholding a currently dominant, status quo moral valuation, and is trying to pre-empt moral challenges to his preferred moral state of affairs. In this case, at his core Posner believes in the morality of wealth-makes-right, and argues from that permise, albeit in a sophisticated disguise. Ann Coulter in philoposphical drag.)

    Part of why Posner doesn’t want accusations of turpitude is that a core existential objection to “Too Big To Fail” is based on freedom and morality. We must not live as the hostages of gangsters. But the only solution is to get rid of such institutions.

    So if your agenda is the aggrandizment of thse institutions, as Posner’s is, then of course you object to any line of argument which would bring any value into play other than pure economic “efficiency”.

    (This too is a bogus, relative value. This financial system is “streamlined” only from the point of view of the corporatist conveyance of loot from the people to a handful of feudalists. From every real world point of view – energy, the environment, food production, real economic production, basic financial security for the people, health care, basic happiness – it is grotesquely “bloated”.)

  10. By Posner’s logic, the govt. should seek out all areas where the law fails to reinforce actions that the general population considers ethical.

    And regulate them.

    The misconception that legality ==> morality, along with hundreds of millions of US citizens watching this morality play in grotesque detail, will end up dissolving the very glue that keeps Posner’s system intact. No market system can operate without this glue, due to transaction costs, information asymmetries, and incomplete contracting. The glue may not need formal authority to function continuously, but it dissolves when it is not reinforced by formal authority.

    A number of behavioralist economic studies have shown that in the short term, people behave “fairly” even when its against those incentives. However, if people repeatedly observe other individuals gaining by behaving unfairly, and they have no opportunity to punish those individuals, they stop behaving fairly themselves.

    For example:


    The pure rationalist-economic philosophy of Posner is rapidly going the way of the dinosaur. Hybrid behavioral/rationalist theories that pragmatically explain real-world phenomena are quickly replacing it.

  11. The conservatives have run the “blame the government” habitrail for decades now – and it’s old! Old as Reagan, actually.

    It’s time to wake up, smell the coffee and point the finger of blame not just at government, whose policy decisions over the years (deregulating the thrifts back in the 1980s and Greenspan’s money dump in recent years and yes, even Paulson’s TARP) have contributed to the terrible economy of today.

    Let’s also acknowledge the stupidity and blindness of the executives leading the charge to turn business into a glorified casino. Let’s hold those highly compensated, highly educated people accountable for having so much debt on their books it froze up the system and required a massive federal bailout.

    Strange how defensive people like Posner get when their dreams of an unfettered free market turn into a nightmare.

  12. Accountability, for many individuals have become a one way street. Only the lowest person on the ladder is accountable for their actions. Meanwhile, businesses and governments are not accountable.

    Accountability is more then a slogan, true accountability actually has consequences.

    A homeowner that walks away is making an economic decision that will have consequences in their credit scores for many years to come. Credit scores determine what credit will cost you in the future and is used in making hiring decisions. Are they not then accountable for their decision?

    Under Posner’s analysis the business is not responsible. No accountability there.

  13. Posner is right in one key respect: Its all about incentives. While regulation has a place, it is difficult to image a regulatory regime that will be able to anticipate every eventuality. Regulators will inevitably be a couple of steps behind the actors in the financial system. Incentives on the other hand will always guide behavior. The trick is getting the incentives right and keeping them simple.

    There is a tendency demonstrated in Congress, the administration and in many of the comments on this blog to think that the government can get things right when they actively intervene. There is no evidence for this, whatsoever. On the contrary, intervention of the sort we have been seeing lately always fail and are very often accompanied by growing authoritarianism.

    All the meddling and tinkering with already existent rules does create a sense of instability and disintivises economic actors. When a secured bondholder for example can no longer trust in fair treatment within a bankruptcy proceeding (see GM and Chrysler) the market will be skewed and premiums will be demanded for bond purchases in the future.

    Had GM, Chrysler, AIG and the other insolvent Wall Street firms been allowed to go bankrupt, the incentives already built into the system would have worked perfectly. Shareholders will be warned to monitor boards and management more closely. Management will be averse to agreeing to poison pill labor contracts. Wall Street executives, seeing their wealth evaporate, will insistent on better risk management at the trading desk levels.

    If any change is warranted it would be in the way Wall Street traders and salespeople are compensated. Aligning their pay with the LONG TERM health of their firms could have prevented alot of this.

    I agree that regulatory rationaliztion is important. Simple is always better. National insurance regulation should replace local. The rabbit warren that is current financial regulation should be cleaned up and the FDIC should be empowered to seize large holding companies.

    Blaming Greenspan is all well and good but lets not forget: it was Congress, and more specifically Barney Frank, that allowed Fannie and Freddie to become a buyer of last resort creating the market for junk mortgages.

  14. I would like to add one point. Incentives are forever. Government intervention and endless management of the economy are short term and always short sighted.

  15. I like Posner, and commented on some of the posts, but couldn’t keep up with him. One main difference with him that I have is about the Fed, a subject I’m sensing that you agree with him on. I just don’t buy it. At one point, even Posner admitted that low interest rates accounted for only 20% of the rise in home prices.

    Going forward, the idea of the Fed attacking Bubbles is a very bad idea. For one thing, the Fed, since it has to possibly slow the entire economy with higher rates, will always be slow to stop a bubble in a particular sector of the economy.

    As well, I don’t like the idea of slowing the entire economy to kill a bubble in a particular sector of the economy. It makes more sense to attack the bubble head on. We certainly could have done this with mortgages. I’ve proposed increasing down payment rates as housing prices rise, relative to the rest of the economy. See, because they’re going up, and getting more expensive, the standards for getting a mortgage should get stricter. Oddly, the bubble allowed the riskiest buyers to borrow at the top of the market. I’m sorry, but you can’t blame interest rates for that asininity.

    Finally, you mention Utilitarianism, a view I don’t accept as useful. From my point of view, Utilitarianism is Behavioristic and Mechanistic, which is why Posner likes numbers such as interest rates. There’s a constant misuse of Correlative Reasoning with these positions.

    Lower Interest Rates are an Incentive. One incentive among the many Incentives and Disincentives that human beings encounter each day. At most, and I don’t even credit that this figure is correct, Interest Rates accounted for 20% of the rise in home values. At most, some buying of homes made sense when interest rates were low, but it is a small amount of what we saw.

    There are a number of other causes for the bubble in housing prices, with Fraud being the foremost among them. No one, and I mean no one, can make lending to the riskiest buyers at the top of a market make economic sense.

    Philosophically speaking, there is a difference between Human Agency Explanations and Mechanistic Explanations. Posner usually falls into the Mechanistic camp.

    On the positive side, I generally find Posner reasonable, fair, and politically pragmatic, which is why I like him. Nowadays, those qualities are in short supply.

  16. Is it morally wrong for a seller to gain advantage from a buyer (or vice versa) when all salient facts of a transaction are disclosed to each party? Freedom of both parties to transact WITHOUT perfect knowledge is at the core of market economics.

  17. “To simplify his importance greatly, he helped shift the legal profession, including both the academy and the courts, from a focus on justice – law should redress the harm suffered by the victim – to a focus on incentives”

    Ah! From the morality of the twelve year old to the morality of the six year old.

    “Law should create incentives that will produce the greatest good for society in the future.”

    Ah! From that which is difficult to assess to that which is damn near impossible to assess.

    The increase in difficulty has practical consequences. By increasing the guesswork and supposition that underlie the arguments, it increases the role of rhetoric and special pleading, and the significance of different social and political philosophies and ideologies in the administration of justice. Is that good for society in the future? If you go to the hospital with an injured left little finger, can you imagine doctors deciding to amptutate because that is the cheapest alternative and society as a whole in the future will hardly miss your finger at all?

  18. “From [Posner’s] standpoint, if you want to focus on how the system should change in the future, it makes sense to look at what government can do and not at what individuals in the financial sector should do.”

    From that standpoint, Bill Maher’s “Chinese” suggestion makes sense: Pick at random a couple of Wall Street executives who were involved and hang them. That would affect the incentives for Wall Street. ;) You can make an excellent case that society as a whole would benefit in the future.

  19. “Moral blameworthiness does not enter the equation.”

    As well it shouldn’t. The “thoroughly utilitarian” approach, that only concerns itself with causation strikes me as being the correct one – otherwise you end up with a large body of “shadow law,” that isn’t codified anywhere, but that people are accountable to nonetheless, regardless of whether or not they actually with it. And how large of a consensus is required for a moral judgment to become enforceable?

    Under what other circumstances do we punish people who follow the rules because of a subjective determination that they violated the spirit while following the letter? The normal answer is to accept that they got you this time, and then to tighten up the rules.

    “The implicit principle is that whenever a major institution does something wrong – but not illegal – we have to overlook it, because we are more dependent on that institution than it is on us.”

    Or… we could suffer the consequences of being dependent on an institution that isn’t dependent on us. Posner’s point, and I’m willing to bet that he’s right, is that we aren’t willing to suffer the consequences that our dependency on large institutions creates. A need for something doesn’t create a right to that thing, in that it creates an obligation on the part of someone else to provide it.

  20. “If you go to the hospital with an injured left little finger, can you imagine doctors deciding to amptutate because that is the cheapest alternative and society as a whole in the future will hardly miss your finger at all?”

    Yes, actually, as we don’t have unlimited resources. If someone else needs to pay to heal my finger, then they can determine the best use for their resources. I might be very unhappy about that fact, but then it’s incumbent on me to have the resources to pay for the treatment that I feel is appropriate.

  21. anne: “The conservatives have run the “blame the government” habitrail for decades now – and it’s old! Old as Reagan, actually.”

    Older, I think. I once read — sorry, I don’t remember where — that in 1928 the president of the U. S. Chamber of Commerce (IIRC) said that gov’t servants should not do a good job, for fear that the people would come to rely upon gov’t too much. Anticipating Katrina by almost 80 years!

  22. Concur.

    OT: By the way reciprocity among nations in global trade would go along way towards eliminating trade imbalances.

  23. Marty: “There is a tendency demonstrated in Congress, the administration and in many of the comments on this blog to think that the government can get things right when they actively intervene. There is no evidence for this, whatsoever.”

    Oh, I don’t know. I think that there is evidence for the relative effectiveness of beat patrolmen in keeping crime down over police cruising in cars. Sting operations also seem to be effective. Maybe financial regulation is not active enough.

  24. @Don the libertarian Democrat

    Hi! I’m a Green libertarian myself. ;)

    “Going forward, the idea of the Fed attacking Bubbles is a very bad idea.”

    Well, I think that President Andrew Jackson’s point is a good one. Better to ruin 10,000 families now than 50,000 later.

    A business cycle is probably a good thing, but boom and bust is taking things too far. We need negative feedback mechanisms, to keep things from getting out of hand. And that is true on both the upswing and the downswing. Maybe the regulations put in place in the Depression were not perfect, but they kept us on an even keel and laid the groundwork for prosperity.

  25. Neither beat cops nor sting operations prevent crime. Crime still exists.

    Crime too is a function of incentives (most of the time). Employed people don’t rob stores and well paid government employees are less likely to be corrupt (see Singapore).

    I would agree that avoiding jail time is huge incentive to the average person. But unless you criminalize risk taking it will be unlikely that regulation alone will solve anything.

    By the way, the current melt-down was preceded just a few short years ago by one of the most comprehensive regulatory impositions in a generation: Sarbanes-Oxley.

  26. We have a tendency as a species to believe that there is a solution to every problem, that we can figure our what the solution is and we can make it happen.

    That has been the folly of dictators since time immemorial.

    In truth relying on human nature to do what it will always want to do, pursue self interest, is a greater guarantor of prosperity and freedom.

    Just ask Adam Smith and the Founding Fathers.

  27. Once upon a time, “conservatives” believed that there are laws higher than those written by men, that individuals have a duty beyond the maximization of profit (or “utility”), that human rights are secured, not granted, by governments, etc.

    When you refer to Posner as a “conservative”, I am not sure whether you are misusing the term, or whether it no longer has the same meaning.

  28. A few things about incentives and regulations:

    1. If Posner is concerned that the government’s demands make it uncomfortable for the financial institutions to stay in bed with the government, doesn’t that counter his incentives argument? Isn’t that what we want, disincentives to take government largess so they get off of it as soon as possible? If they absolutely can’t the regulators can make them stay anyway. (like denying TARP repayments for another few weeks)

    2. There are incentives and there are incentives. Greenspan was partly right when he talked about the system correcting itself. If bank execs and mortgage brokers, and CDS insurers, and ratings agencies etc., etc. were incentivized over ten year time frames; if mortgage brokers got paid as borrowers repaid the loans, if CDS insurers got paid upon expiration of the contract, if ratings agencies got paid based on the back-tested track record of their ratings etc. then the incentive system works. If I can make $100 Million dollars in one year and never have to give it back no matter what I do, then it doesn’t.

    3. There has been a major breakdown in the check and balances of stock ownership. The Agency problem is rampant and allowed executives to make these huge amounts of money in the very short term. If the banks were required to pay their profits as dividends to shareholders many things would have been prevented. As I’ve recently written in my business newsletter, the electronic world of stock ownership has stripped out the sense that shareholders actually own a company, and has substituted a sense of shuffling slips of paper around. As such, boards of directors got stacked and execs. could do whatever they wanted. With a majority of shareholders owning stock shares three or four steps away, through mutual funds where the managers of the funds don’t want to participate in the companies they own, or through pension funds with similar mandates, or through on line trading accounts where they own tiny share amounts, and only for a few weeks at a time, the supervisor of the executives – the shareholders, don’t perform that function any longer. I don’t think we’re going back to the days of having an EF Hutton account and owning five or six stocks that you hold for ten years and actually thinking about and voting on the proxy materials – so unfortunately the government will have to step in somewhat to restore the balance.

  29. Actually Posner is extending the traditional legal approach toward literal rapists to corporate financial rapists. It is the victim’s fault for tempting the perpetrator.

  30. Maher said that? I didn’t know anyone besides myself had suggested such a thing.

    The fact is, an argument like Posner’s, which cleanses the situation of all moral implications, can always afford equal and opposite conclusions.

    Posner wants you to draw the conclusion that financial cadres are simply “doing what they do”, what they’re existentially fated to do to whatever extent government allows them, so you shouldn’t blame them at all, but rather blame government. (Which really means, let them off the hook, and even allowing them to keep the loot.)

    But we could just as easily conclude that this means such walking incarnations of sociopathic greed are a kind of rabid dog which must be put down as a public health measure. After all, Posner himself says they’ll never stop trying to commit these crimes, and that for as long as these criminals exist you’ll never be finished with the struggle and the required vigilance.

  31. Posner loses a ton of credibility when he uses Alan Greenspan as an example of a ‘government official’. If Posner does not understand the basic fact that the Fed is a private [not public] institution, how much credence are we to give to the rest of his arguments?

  32. I haven’t read Posner, but he sounds like another case where his intelligence and analysis are ultimately inconsequential because he’s saddled with preconceived notions. He does not use his academic prowess to determine the truth, but instead to buttress his predetermined outcome.

    In short, another who sees capitalism and free markets in the light of a religion, rather than a science.

    It’s time we stop venerating people simply on their ability to simulate intelligence, but rather on their ability to exhibit both intelligence and wisdom. The two unfortunately do not automatically go together and great suffering has ensued for societies unable to see so.

  33. Cops do prevent crime.

    They do not, however, prevent all crime.

    Suggest you read Steven Levitt’s stuff.

  34. Another fine article, Mr. Kwak!

    People are hardwired to live by fairness, but will, confronted by its absence, cheat. Our government’s approach to financial cheating and the cheating cheaters who create the cheats simply forces everyone else to cheat just to get by.

    Today’s tough economy calls for a new breed of financial engineering geniuses who will invent higher orders of cheating that make yesterday’s cheaters look like a shoplifter carrying a roast turkey under his sweatshirt. And I for one am confident that America’s Ivy League schools will deliver these geniuses. They have never failed to do so in the past.

  35. Among the great features of the great men (and women) of that era, was their capacity for original thought and action. They tended to believe in the possible, rather than the impossible.

    Defending the position of government inaction in the face of systemic corruption is a stiff task, and would surely benefit by citing detailed facts rather than general platitudes and appeals to authorities (who, by the way, would be less likely to agree with the opinions you are presenting than you might think).

  36. Don,

    The attitude toward risk you cite is a symptom and not a cause for a bubble. Easy money changes the perception of risk. If you change the characteristics of one asset class, the money will find a home elsewhere to the same end.

  37. While generally agreeing with the thrust of your remarks, I think you need to keep in mind that ‘trust’ like ‘authority’ and political ‘legitimacy’ are remarkably ineffable qualities in societies. They appear to be the product of longer term institutional development. The norms, values, and socio-cultural practices. Avner Greif has examined this sort of development comparatively (trecento Genovese merchants contrasted with their Maghrebi contemporaries). What is dificult is that when trust, authority, or legitimacy are damaged they are not readily ‘repaired’ by setting new rules.
    A decade or so ago there was a flurry of interest in ‘low trust’ versus ‘high trust’ societies: Francis Fukuyama weighed-in in the wake of Robert Putnam’s “Making Democracy Work”which in turn, was indebted to the older work of R. Banfield (Moral Basis of a Backward Society -good reading if you want to understand executive compensation). These authors (in explaining Italian under-development as a classic ‘low trust’ society [at least in the mezzogiorno]) took note of endemic suspicion of other’s motives as a hall mark of lack of trust. Americans have always (since the Framers) been hostile to centralized political power but generally trusting of private action (i.e. in the market). The Great Depression brought into question trust in the market, even its legitimacy, and certainly the authority of business leaders. I think the same has happened again in this crisis and a resurection of Benthemite ideology ( a propos Posner) is unlikely to rectify a dramatic loss of trust and legitimacy, much less authority.
    I dont have it at hand to quote but I recommend Ian Shapiro’s critique of Posner (in Flight from reality in the human sciences).

  38. Reducing the criminal laws and the cops to the same level as deregulation and minimal enforcement in the markets and you would result in an explosion in crime.

    Sarbanes-Oxley is a small part of the picture. It has not eliminate FASB’s loose accounting rules, nor did it address the problems in lending, or derivatives.

    Law, regulation and enforcement help prevent crime.

  39. If government regulation was a one way street then Posner’s analysis would make sense.

    However, as experience demonstrates, private interests have the ability to influence the regulatory process.

    Some private interests exert a disproportionate influence. Influence is a kind of authority. Authority carries with it responsibility.

    It’s not like the big players on Wall Street have been a marginalized in recent years and purely subject to the whims of regulators. In many ways the big players in Wall Street were in bed with the regulators. They effectively shut out other stakeholders.

    Posner’s analysis makes no accommodation for the existence of regulatory capture. I’m curious to know why his theory excludes this outcome. Does he believe that “regulatory capture” is a fiction? If so, based on what line of evidence?

  40. “because of the manifest inability of the government to manage banks competently”.

    So does Posner think someone with pedigreed Wall St. credentials would do a better job? Maybe someone like Stan O’Neal or Chuck Prince? Sure sounds like it. I wish there was a way to see how well they would have run a bank…oh wait, there is. And as for his “efficient breach” idea…seriously??? Would he be horrified by the phrase “A man is as good as his word”? He may not be aware but alot of business (outside of NYC) in this country is still done with a handshake. This guy’s a joke.

  41. Hmmm . . . I’m sort of waiting for someone to show up and tell me I got Posner completely wrong. Anyone?

  42. It is impossible to estimate the damage the law and economics approach to law has done to society, not least by convincing lawyers that they can do competent economic analysis. (I for one have had to tell my lawyer many times that I didn’t ask him to analyze the economics or business implications of a deal, and I’m not paying him for it)). Humans have evolved to engage in moral reasoning, it’s something we do naturally; we have not evolved to make competent projections of economic outcomes in modern economies.
    Following StatsGuy, I wonder if Posner’s analysis takes into account the damage that broken contracts can do to the rule of law. I would think that, in a given deal, if either side expects the other to break the contract at some point, the reservation prices of both sides would be higher. While a weaker dedication to contracts may lead to more explicitly specified damages in the case of a breach, I think that, over time, the “efficient breach” practice would drive up the price of doing business generally. Maybe Posner should spend some time studying drug-dealing markets (illegal ones). Contracts are strong in that world only because they’re backed up with the threat of violence.
    Posner is right about one thing, though: academic economists should take some of the blame.

  43. Excellent post James. I can’t reply about Posner as I’m a beginner but I do know I share your point of view. Posner seems to detached from the human element. I sometimes think that helps when you hold conservative social views.

  44. You seem to get one thing wrong, at least: Greenspan didn’t act on a clear mandate to regulate shady mortgage origination practices; if he had, there would be a process by which to morally blame those who you consider to be the true culprits. If there were laws to constrain these practices, and people violated them, there again there would be a process by which to shame them convincingly (and jail them). In that sense, even if you believe these practices to be morally wrong, the regulators and legislators are ultimately to blame, because they weren’t doing their jobs and constraining immoral behavior. You could blame the shady originators, but that’s not going to fix anything. (One of my acquaintances in the shady world of boutique finance is a former shady mortgage originator, and he doesn’t even seem to be aware that what he was doing was wrong. Often, people got shuffled into subprime because some canned computer program told the originating officer to do so. It’s also an open question the degree to which the Wall Streeters who packaged this ill-gotten paper were aware of the practices that generated it.)
    In the post, Posner seems more interested in analyzing the economics of the situation, not the morality; he even points out that the blame directed towards Wall Street has been efficient in defusing social tensions that could constrain policy-making.

  45. You do slightly misrepresent posner. He doesn’t blame government for any ideological reason; he is after all a “pragmatist” (in the true sense of the word). I think that his point boils down to this: what is the point of blaming “greedy bankers” when they are just playing by the rules that the government set? We cannot change the reality of human behavior; the only thing we can change is the regulatory framework (and we should probably do that with caution, at least at this fragile time). At bottom Posner is realistic (again a pragmitist in the true sense of the word), and painting him as some sort of ideologue is a bit absurd (see almost every comment above). I agree with him that there is little utility in punishing people for operating in a system that our government has created.
    Also, please explain to me how Posner’s concept of blameworthiness is “patronizing.”

  46. I think we all need to sing…and dance….as our futures and the futures of our children seem to be getting flushed. I know!! Let’s all waste tremendous amounts of time “blogging”, while the thieves continue to rob us blind! Wonderful.

    I plan to purchase additional ammunition, in anticipation of the inevitable.


  47. However, those government rules weren’t set in a vacuum. Many of the rule changes were enacted precisely because of advocacy on the part of private interest lobbies.

    If banks had no influence in shaping policy and were merely passive agents, then OK, Posner’s line of reasoning makes sense.

    The fact is that the big players were active participants in creating the public framework.

    Perhaps ordinary citizens bear some responsibility for assuming, mistakenly as it turns out, that federally elected officials and government regulators would weigh larger public interests in the balance.

    But a “pragmatist” should at least understand that a clever thief is still a thief.

    It stands to reason that the relationship between those who pocketed the upside, and those who lost out on the downside won’t be the same. Especially in a case where the people who enjoyed the upside benefit find a way to dump the bill onto someone else when things turn south.

    Posner’s line of reasoning is a little bit like an adulterer claiming after the fact that his (or her) spouse bears primary responsibility for the infidelity.

    To the extent that it’s a pragmatic view of human economic interactions, it argues for a robust, independent, oversight authority of private markets. It also suggests that the influence of big private players in shaping the regulatory framework needs to be substantially curtailed.

    Otherwise the big players will cheat.

    Posner may condoning the cheating of private actors, but he can’t escape the logical outcome of his position — especially as it relates to the role of public watchdogs.

  48. “efficient breach” is a big enabler for amoral or immoral behaviour. Once that principle is established, breaking the contract is always on the table, and then it’s a jungle, where only the big dogs win.

    No set of regulations or laws are perfectly enforceable. Rather they are a set of agreed-upon limits, and it is this agreement and most people’s sense of morality that cause the majority to follow them. Remove the consequences of unethical action and you’ve just punished everyone who operates ethically.

    csmith: Is it morally wrong for a seller to gain advantage from a buyer (or vice versa) when all salient facts of a transaction are disclosed to each party? Freedom of both parties to transact WITHOUT perfect knowledge is at the core of market economics.

    It’s morally wrong to obtain and exploit advantage in a manner that causes harm to individuals, groups or the “system” (the economy, society). Everyone’s free to profit, no-one’s free to cause injury.

    To me, the proper arrangement is that the market and the economy is free to operate in a box, the floor of which is set by a livable minimum wage, and the walls made up of regulatory action. One hopes that ethics and honour would also be part of the container.

  49. Ken:

    So if I have a more fully developed perspective on a marketplace or specific investment and I sell that investment to someone who is, how should I say, “less sophisticated” and the investment value subsequently falls, I’m in the wrong morally?

    To economists, this is the very definition of market efficiency. A system in which the rules are written to benefit the most efficient rather than the least exhibits greater material progress over time. In a mixed economy, government intervenes to transfer a subsistence level of production from the more efficient to the least. Once the rules are written to benefit the least efficient, however, to the extent they impair productive activity, the slippery slope is reached. With nearly 50% of the U.S. population now willing and able to vote themselves a pay raise, we’re close to the edge.

  50. No, James. You hit a home run.

    Years ago I used to use Posner’s example of selling babies both to simplify the economics involved and show students what an amoral, “efficient” world would look like. No matter how sincerely and carefully we tried to defend the Posnerian position we never had any takers in the end.

    Having said this, I do believe that a better case could be made to defend Greenspan on Schumpeterian grounds. I still think the argument loses but it would place Greenspan in a more thoughtful, if not sympathetic, light.

  51. James, I find I am sympathetic to Posner’s pragmatic approach. For one thing, systemic risk is necessarily diffuse. Which individual actor can be blamed for actualizing a systemic risk? Therefore, concentrating on incentives is the correct thing to do. I also agree with Posner that government bears the primary responsibility for this crisis. Rather than doing the straightforward thing – subsidizing mortgage payments for low income home buyers, if that’s what Frank and Dodd wanted – the government leaned on Fannie, Freddie and commercial banks to loosen their lending standards, with the results we all know. By mandating that certain institutions hold AAA securities and giving a charter to Moodys et al to establish those standards, the government created incentives for misclassification of risk. The blame approach assumes that ridding the system of a few “bad apples” will solve all our problems, when what is needed is a change in incentives. Other people, wiser than I, have pointed out that allowing the investment banks to move from a partnership organization to a corporate one created hideous incentives to seek out risk in order to make one big score and get out with huge bonuses. Perhaps IB officers and directors should have to risk their own capital, while commercial banks should have to work with low leverage and no off-balance-sheet entities.

    As an aside, I find the “efficient breach” idea to be unsound. While it might be efficient in the aggregate, Posner seems to assume that the actors will interact only once. If you are burned by an actor who breaches his contractual obligations, are you going to contract with him again? In fact, assuming the breach is public news, how many other actors will decide not to sign contracts with a known breacher of contracts? Here, Posner assumes that he knows all the factors that lead to aggregate efficiency, but this is unlikely to be the case, especially if trust is diminished as a result of the “efficient breach”.

  52. This is a false dichotomy. We do not have to choose between perfect regulation and no regulation at all.

    Some regulation works. Some doesn’t. The trick is to get it right. And better regulation is one one piece of the puzzle.

    This is hard work. But the tendency to throw up one’s hand and say that because the results aren’t perfect means we should do nothing will get us nowhere.

    The perfect here is the enemy of the good.

  53. i don’t think you’ve given us enough information here to make that judgement.

    One could also say that the tendency to make sweeping theoretical generalizations is also at the core of market economics. And our present form of market economics isn’t working particularly well.

  54. From Ed Yardeni:

    Meanwhile, the Dependency Ratio is soaring. The ratio of government transfer payments to individuals divided by wages and salaries rose to a record high of 31.4% in April. It was less than 10% before the start of the Great Society in the mid-1960s. The problem is that rather than raising taxes on wage earners to pay the beneficiaries of the government support programs, the US is funding more of such spending through deficit financing. The “Nanny State Deficit” totaled a record $565.2bn (saar) during April. It is simply the gap between the social benefits provided by the government minus the payroll taxes paid by employees and employers to pay for them. This deficit was close to zero at the start of 2001, when the data are first available in the monthly personal income release.

  55. Posner, is, of course, right, on a purely amoral theoretical basis. I happen to side with James, although I feel very strongly that the overlobbied Congress has let down the taxpayers by failing in its oversight and regulation of an instinctively greedy group of Wall Streeters and fat cat bankers.

    But, to James point, the public does have a right to require its citizens, whether super rich or super poor to be fair and reasonable in what they do to make money. What has happened because of the immoral and amoral behavior of the usurers, is that the public has generally lost all faith in that community, and trust is a key element in moving our world and economy forward.

    It is now up to the government to reregulate, and to expose the a- and im- morality for what it is, and allow it the opportunity in the newly regulated environment to stop its focus on immediate profit to the detriment of long term societal gain. There have been a few admissions of “what we should have done (or not done)”, but the future will be the ultimate arbiter of success in overbridging the chasm that still confronts us. Without agreement and cooperation among all sectors, there will not be uniform progress or progress at all.

    The guys like Posner are practicing Ivory Tower legal economics, and are not interested in anything but making their points. Meanwhile those who accept what he speaks are just participating in the poisoning of the waters of progrss, and not finding solutions. I think that he would ultimately lose in any face to face debate with Simon or James, or even Paul.

  56. csmith: …So if I have a more fully developed perspective on a marketplace or specific investment and I sell that investment to someone who is, how should I say, “less sophisticated” and the investment value subsequently falls, I’m in the wrong morally?

    I believe in a free market, inasmuch as the affected parties are voluntarily in the market. So in the example above… sure, caveat emptor. Assuming of course that the seller isn’t actively engaged in a fraud of some sort, like selling sub prime debt as AAA-rated paper.

    Being “less sophisticated” myself, I’m finding all this market theory interesting. Which is nice because since being laid off, I have to spend more time reading and stuff. But I do suspect that the prevailing marketing “theory” you refer has maximum efficiency mainly for those running the market. It’s sure proven deadly efficient at stripping taxpayer money and livelihoods. Wealth-generator, indeed…

    But seriously, theories aside, what in your opinion is the place of ethics, morality in the modern market?

  57. csmith: …So if I have a more fully developed perspective on a marketplace or specific investment and I sell that investment to someone who is, how should I say, “less sophisticated” and the investment value subsequently falls, I’m in the wrong morally?

    Let me go at this one again.

    In clearing up the affairs of my late father-in-law, who was a longshoreman, we came across an envelope of stock certificates from the late 80’s, sold to him by a broker. The vast majority of the stock became worthless junk within months of the sale.

    So… was the broker acting immorally by selling junk to a longshoreman, who was simply looking to invest for retirement? F’ing right he was. If I ever catch up with the guy, I’m going to stuff a large-print hard-bound copy of “The Wealth of Nations” right up his a$$. Now that’s a proper application of theory.

  58. The principle you indicate posner has on breaching contracts seriously bothers me. If one enters into a contract one shouldn’t easily be able to breach it because paying whatever penalties is cheaper than following through. This strikes at the notion of trust that the entire financial system is built on. If you can’t trust that you can make a binding contract then what can you trust?

  59. Ken:

    You said you believe in free markets. How much responsibility did your father in law bear in choosing poor “investments”? How much research did he do with regard to the investment acumen of his “broker” and/or his track record? CDs exist for a reason.

    Your question w/ regard to the place of morality in markets goes to the same issue. Rubes get fleeced. If you don’t know what you’re doing, DON’T PLAY. Some minimal level of responsibility rests within the individual to recognize WHAT YOU DON’T KNOW and act accordingly. Fool me once, shame on you. Fool me twice, shame on me. Diversify, act incrementally, understand what you own and what it is worth and avoid the crowd (i.e.;don’t overpay).

  60. Ok, I’ve sold things professionally too. If someone comes to me to make a purchase based on my knowledgable recommendation, and I intentionally sell them something that I know is unsuitable for their purpose, I’ve acted immorally. My stepfather didn’t go to a broker and ask for a fistful of junk.

    I hear you re DON’T PLAY… but first of all we’re all encouraged, expected to plan and invest for retirement. Second, even for those of us NOT actively in the market, we’re now getting the consequences.

    Enough digression. Last point – the market exists to advance society, not the other way around.

Comments are closed.