No one embodies the dangers of crony capitalism more than Robert Rubin. I was reminded of this when reading a provocative new book called A Capitalism for the People: Recapturing The Lost Genius of American Prosperity by an economist named Luigi Zingales. It’s an excellent read, a populist screed that will resonate with Occupy Wall Street, the Tea Party and anyone who worries that corporate power is deployed in Washington to benefit the well-to-do at the expense of most everyone else.
Rubin’s story illustrates the trouble with the unholy alliance of big business, big government and wealthy elites that rule today’s Washington. Few who travel the Amtrak corridor have a more elite pedigree: An Eagle Scout, Robin’s resume includes a Harvard B.A., a Yale Law degree, a brief stint as a Wall Street lawyer, a top job at Goldman Sachs, seven years in Washington as an economic advisor and Treasury Secretary to President Clinton, followed by a triumphant return to Wall Street, as a director and chair of the executive committee at Citigroup.
As Zingales tells the story, Rubin during his years in Washington was a leading advocate for financial bailouts, beginning in 1994 when the collapse of the peso jeopardized Mexico’s ability to repay big lenders including Goldman and Citi. Mexico avoided default but, as Zingales writes, “this move eliminated fear among lenders, and fear is an essential element in financial markets: it disciplines financial decisions.” To function properly, market capitalism needs to be about losses as well as gains, a lesson any investment banker should understand. But Rubin went on to support IMF bailouts for Thailand, South Korea, Indonesia and Brazil, each of which shielded US lenders from losses–emboldening them to take future risks as they came to believe, correctly, that governments would not permit them to take heavy losses. Here were the beginnings of “too big to fail.”
Zingales has a nice analogy about bailouts, comparing them to grandparents who spoil their grandkids when they parents want to discipline them:
Grandparents have an incentive to spoil their grandchildren, since they benefit from the grandchildren’s gratitude and from the momentary peace–but they are unlikely to suffer the long-term consequences of the kids’ bad behavior (partly because they aren’t around as much, and partly because they die sooner). In much the same way, policy makers are happy to bail out firms and countries because they benefit from the momentary improvement in the economy and from the gratitude of saved business–but they’re unlikely to suffer the long-term consequences because they will be out of office by the time the perverse results occur.
Meantime, Rubin opposed other efforts to rein in the banks. Along with Alan Greenspan and Larry Summers, Rubin beat back efforts by Brooksley Born, the head of the Commodity Futures Trading Commission, to regulate the over-the-counter derivatives, including the credit default swaps that later contributed to the 2008 financial crisis. Rubin and Summers also argued successfully for the repeal of the Glass-Steagal rules that for the most part prohibited banks that held government-insured deposits from engaging in risky and speculative investments.
His work done, Rubin exited the government for Citigroup from which he earned $126 million during the 2000s. During the 2008 financial crisis, Citi was favored with a $25 billion infusion of equity under TARP, $20 billion of equity from the Treasury and another $306 billion more in government guarantees of its so-called toxic assets. Citi never sleeps, the slogan goes, but its directors, including Rubin, evidently did, as the Wall Street Journal noted. Or at least he slept until the time came to seek a rescue from Washington.
In another land–one where the press was more aggressive, and power brokers like Rubin were held accountable for the damage they help to cause–this set of actions might send a man into hiding, or at least retirement. Not so here–he remains a respected voice in Washington and a Harvard trustee. Indeed, Rubin has now earned honorary degrees from Harvard, Yale, Penn and Columbia, fully half of the schools in the Ivy League. (Why Princeton, Dartmouth, Brown and Cornell have passed him over, so far, is anybody’s guess.)
I write this not to single out Rubin, who quite probably believed he was doing the right thing, as did his successors at Treasury, Hank Paulson (who I wrote about in 2008 and came to respect back) and Timothy Geithner. But, as Zingales argues, many of us who believe that capitalism and robust markets and competition can be powerful forces for good have become complacent about the dangers of well-meaning but corrupt elites who have rigged the system for their own benefit — with corporate bailouts, vast expenditures on lobbying (a staggering $3.3 billion in 2011), regulations that protect entrenched interests, tax policy that favors the rich, the ever popular “public-private partnerships” that transfer wealth from public coffers to private owners and an ever-expanding array of market-distorting subsidies for farmers, manufacturers, automakers, oil and coal companies and, yes, the wind and solar power industries, too.
Zingales puts it this way:
…crony capitalism has corrupted American society. A subsidy-driven market selects not the firms most efficient at producing but those most efficient at sucking up public resources. How did the land of opportunity become the land of rent seekers?
Good question. A big reason corporations direct ever more of their attention to winning favor in Washington is that the government has grown. Federal spending makes up about 22 percent of the American economy today, up from 3 percent a century ago. Follow the money, as they say.
Besides regulation, at least as it has generally been practiced, has failed to curb the power of big business. In the Progressive Era, when Americans worried that business was becoming too powerful, they responded by expanding the regulatory power of the state. The Depression, too, brought more government oversight of business. In a speech announcing the second New Deal, Roosevelt famously said of the bankers, speculators and war profiteers: “They are unanimous in their hate for me–and I welcome their hatred.”
But, as Zingales writes–and as I have come to believe, after more than 20 years of covering business while living in Washington–the expansion of government regulation has created and not limited corporate power. He writes: “All too often the state is part of the problem and not part of the solutions…most of the time rules are designed to protect the incumbents and discourage, thus damaging competition.”
Economists call this regulatory capture, and it’s a well-documented phenomenon. Recall, most recently, the SEC’s failure to heed warnings about Bernie Madoff and the hapless performance of the Minerals Management Service in monitoring offshore oil drilling before the BP spill. In neither the financial crisis nor the oil spill did government regulators prevent reckless risk taking.
By contrast, consider what happened when airlines were deregulated–fares went down–and when the AT&T monopoly was broken up. I’m old enough to remember when people rushed off the phone for fear of running up a tab on a long distance call. True competition is a marvelous thing.
Most Americans understand that the system doesn’t work for their benefit. When the Pew Research Center asked in December, 2011, “Do you think there is too much power in the hands of a few rich people and large corporations in the United States, or don’t you think so?,” more than three in four respondents answered yes. But channeling that discontent into constructive citizen action is no easy feat.
For his aprt, So what is to be done? Zingales outlines a pro-markets, pro-competition agenda. This is different from a pro-business agenda, and it always has been. In The Wealth of Nations, Adam Smith argued on behalf free market but worried that business people would collude to limit competition. In an oft-quoted passage, he wrote:
People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.
While the rhetoric of business people favors open markets, companies do their best to hamper competition. Indeed, investors love companies that dominate industries in which there are barriers to entry. “In business,” Warren Buffett said famously, “I look for economic castles protected by unbreachable moats.” Within acceptable limits, that’s not a problem. Apple’s designs, Google’s speed, Coke’s brand are all moats, fairly earned. But the government’s role should be to promote fair competition, not to favor one company — Citi, GM, Solyndra, Halliburton or Exelon, as The Times recently reported — over rivals.
Zingales does not oppose regulation. To the contrary, he argues that it is required, to limit corporate power or curb pollution. But like his University of Chicago colleague Richard Epstein, Zingales says regulations should be simple and transparent, to reduce the likelihood that they can be manipulated. The Dodd-Frank financial-reform bill, he notes, was a 2,319 pages long. (Glass-Steagal ran 37 pages when it was enacted in 1933.) The Waxman-Markey cap-and-trade bill topped 1,000 pages; no wonder people worried about utility companies and fossil fuel interests gaming the system.
How would simple regulation work? In the energy sector, which I know best, it could take the form of a rising tax on carbon emissions, with all revenues returned to people either through reduced payroll taxes or direct dividends. In the financial sector, the government could cap the size of banks (so they could be allowed to fail) or dramatically raise capital requirements. The tax code could, of course, be dramatically simplified, lowering rates and eliminating deductions like the mortgage interest deduction that benefits (richer) home owners at the expense of (poorer) renters.
Lobbying, meanwhile, could and should be curbed. The corporate-responsibility movement, as well as business schools, could play a role here. There’s nothing admirable about special-interest lobbying, and indeed it’s only relatively recently that it has become an accepted part of life in Washington. Zingales dug up this marvelous quote from a Supreme Court justice named Noah Swayne, writing in an 1875 case called Trist v. Child:
If any of the great corporations of the country were to hire adventurers who make market of themselves in this way, to procure the passage of a general law with a view to the promotion of their private interests, the moral sense of every right-minded man would instinctively denounce the employer and employed as steeped in corruption, and the employment as infamous.
I wonder what Justice Swayne would have thought of Robert Rubin.
For more from Zingales, listen to this podcast at EconTalk where he is interviewed by Russ Roberts. EconTalk is a great resource for anyone who (like me) is interested in better understanding how economics works, and the kinds of questions it can and cannot answer.