17  On Honest Men and Honest Institutions

William Krehm

As so often in The New York Times (23/11, "Banks Gone Wild") Paul Krugman, has written a great column. Well, as so often with Krugman, an almost good economist what he has written on this occasion as well were better qualified as "an almost great column."

But let us move into the meat and potatoes of our problem with it. "‘What were they smoking?’ "asks the cover of the current issue of Fortune magazine. Underneath the headline are photos of recently deposed Wall Street titans with the staggering sums they managed to lose.

"The answer, of course, is that they were high on the usual drug – greed. And they were encouraged to make socially destructive decisions by a system of executive compensation that should have been reformed after Enron and scandals, but wasn’t."

That is as close as Krugman approaches the great light, but doesn’t stay with it. Instead of concentrating on what went wrong with our institutions, he gets back to what he sees always more comfortable in – personal inadequacies and vices.

"In a direct sense, the carnage on Wall Street is all about the great housing slump.

"This slump was both predictable and predicted. ‘These days,’ I wrote in August 2005, ‘Americans make a living selling each other houses, paid for with money borrowed from the Chinese somehow, that doesn’t seem like a sustainable life style.’ It wasn’t.

"But even as the danger signs multiplied, Wall Street piled into bonds backed by dubious home mortgages. Most of the bad investments now shaking the financial world seem to have been made in the final frenzy of the housing bubble, or even after the bubble began to deflate.

"In fact according Fortune, Merrill Lynch made its biggest purchases of bad debt in the first half of this year – after the subprime crisis had become public knowledge.

"The losses suffered by shareholders in Merrill, Citigroup, Bear Stearns and so on are the least of it. Far more important in human terms are the hundreds of thousands if not millions of families lured into mortgage deals they didn’t understand, who now face sharp increase in their payments – and, in many cases. the loss of their houses – as their interest rates reset.

"And then there’s the collateral damage to the economy. You still hear occasional claims that the subprime fiasco is no big deal. Even though the numbers keep getting bigger – some observers are now talking about $400 billions in losses – these losses are small compared with the total value of financial assets.

"But bad housing investments are crippling financial institutions that play a crucial role in providing credit, by wiping out much of their capital. In a recent report, Goldman Sachs suggested that housing-related losses could force banks and other players to cut lending by as much as $2 trillion – enough to trigger a nasty recession, if it happens quickly. Beyond that there is the pervasive loss of trust, which is like sand thrown in the gears of the financial system.

"How did things go so wrong?

"Part of the answer is that people who should have been alert to the dangers and taken precautionary measures, instead blithely assured Americans that everything was fine, and even encouraged them to take out risky mortgages. Yes, Alan Greenspan, that means you.

"But another part of the answer lies in what hasn’t happened to the men on the Fortune cover – namely, they haven’t been forced to give back any of the huge paychecks they received before the folly of their decisions became apparent."

When Unlimited Became a Public Virtue

"Around 25 years ago, American business – and the American political system – bought into the idea that greed is good. Executives are lavishly rewarded if the companies they run seem successful; last year the chief executives of Merrill and Citigroup were paid $48 million and $25.6 million, respectively.

"But if the success turns out to have been an illusion, well, they still get to keep the money. Heads they win, tails we lose.

"Not only is this grossly unfair, it encourages bad risk-taking, and sometimes fraud. If an executive can create the appearance of success, even for a couple of years, he will walk away immensely wealthy. Meanwhile the subsequent revelation that the appearances were deceiving is someone else’s problem.

"The point is that the subprime crisis and the credit crunch are, in an important sense, the result of our failure to effectively reform corporate governance after the last set of scandals."

But whereas Mr. Krugman has taken a good run in the direction of the real sources of the problem, he fell short with a thud, and didn’t arrive at its real essence. That is institutional – the control of parliament, our crucial laws, including the freedom of information in parliament, the media, and our universities has been curtailed to cripple the crucial institution involved, and that in turn has to do with the availability of information to enable our information, educational and parliamentary institutions to function.

Where you have functioning institutions of such categories, the success and survival of our society will depend less on the heroism of individuals and on their virtues. Only functioning democratic institutions – our parliament, our universities, and our media can assure that.

That is why we ought to deal with Mr. Schreiber’s information quickly if thoroughly and go on to the real problem of the Mulroney years. Why has the Bank of Canada Act – still on our law books – been disregarded when it would give us the institutional tools to restore economic democracy and hence plain democracy. There is no record of subprime mortgages having been explained to parliament or justified by anything in the Bank of Canada Act, which is still the disregarded law of the land. What we have there is a violation of our duly adopted institutions, that rewards a violation of our constitution. Restore that to where it was when Mr. Mulroney laid hands on it, and globalization and deregulation of our banks and financial systems will not only be contained but reversed.

Until then you will be trying Mr. Mulroney for his peccadilloes rather than for the major mischief that he did during his period as head of our government.

The institutional aspect of the economy and of some other key institutions has simply disappeared beyond the horizon.

William Krehm

– from Economic Reform, December 2007