April 23, 2010

Pornography Did Not Cause The Great Recession

First of all, I hate the phrase "Great Recession." We've got to think up something better. "The Panic of 2007" would be more historically accurate.

Second, it's astonishing that we're being told "more regulation" is the answer to what we are told is a serious and systemic problem when it turns out that the regulators seem to have spent more time looking at websites with names like "skankwire" and "naughty.com" than they did scrutinizing guys like Bernie Madoff. True, Madoff made his financial statements look good but real investigation under existing regulations would, could, and should have revealed that the published financial statements were founded on smoke and lies. It's hard indeed for me to accept the idea that new regulations are necessary when the old ones appear to have simply not been enforced. We'll see what happens with the SEC lawsuit against the giant vampire squid, which is predicated on existing laws, turns out.

Third, the failure of a regulator to prevent a crisis is not the same thing as causing the crisis in the first place. FEMA did not cause Hurricane Katrina. FEMA failed to mitigate the damage from the hurricane by botching the rescue and cleanup efforts. Failing to mitigate the damage is not the same thing as causing it in the first place. What caused the financial crisis was 1) the collapse of the residential real estate and critical commodities (oil, strategic metals) bubbles, which was fueled by 2) the innovation of easy terms of highly flexible credit terms and governmental assent to easy innovative credit, which in turn was fueled by 3) the willingness of financial institutions and their shareholders to richly reward financiers who consistently delivered short-term equity appreciation and unwilling to tolerate financiers who failed to deliver it.

I say "financiers" instead of "executives" because that's what a lot of them were and indeed, still are. They view their job as doing what is necessary to increase shareholder value, rather than maximizing earnings. Therein lies an intractable issue – so long as stock is freely alienable, there will always be an incentive to focus on market price rather than on dividends. The solution, or at least a part of it, may well be really unpopular in a diverse range of political quarters – increasing the costs (that is, taxes) on equity trades while decreasing the costs (that is, taxes) on dividend payouts. Shareholders will then prefer to see the return on their investments as based more on dividend payouts rather than on churning stocks.

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