Don't Blame Wall Street - Blame Congress

Professor Russ Roberts of George Mason University gave the House Committee on Oversight and Government Reform an earful earlier today when he testified in front of the committee about executive compensation and the serious imbalance that exists in regards to over-the-top compensation given to high level executives of failing or failed firms.

While I have a problem with the government setting the pay scales and other compensations for corporations and financial institutions, Roberts does make a case for reining in giving incompetent or corrupt executives excessive pay and perks while everyone else takes it in the wallet.

Americans are angry about executive compensation.

Rightfully so.

The executives at General Motors and Chrysler don’t deserve to make a lot of money. They made bad products that people didn’t want to buy.

The executives on Wall Street don’t deserve to make a lot of money. They were reckless with other people’s money. They made bad bets that didn’t pay off. And they wasted trillions of dollars of precious capital, funneling it into housing instead of... a thousand investments more valuable than bigger houses.

Everyday folks who are out of work through no fault of their own want to know why people who made bad decisions not only have a job but a big salary to go with it.

No wonder they’re angry at Wall Street.

But if we keep getting angry at Wall Street, we’ll miss the real source of the problem. It’s right here. In Washington.

We are what we do. Not what we wish to be. Not what we say we are. But what we do. And what we do here in Washington is rescue big companies and rich people from the consequences of their mistakes. When mistakes don’t cost you anything, you do more of them.

(Emphasis added – ed.)

For far too long we have taken a path that privatized profits but socialized risks, meaning the risks businesses were willing to take became greater because they knew they really wouldn't have to pay the price if things didn't work out. All we need to do is look at the housing crash, Fannie Mae, Freddie Mac, and the string of failed banks holding non-performing loans, mortgages, and mortgage backed securities. And we have Congress to thank for that, Barney Frank's protestations to the contrary notwithstanding.

The question is, have we learned anything from this? Probably not.

Capitalism is a profit and loss system. The profits encourage risk-taking. The losses encourage prudence. Is it a surprise that when the government takes the losses, instead of the investors, that investing gets less prudent? If you always bail out lenders, is it surprising that firms can borrow enormous amounts of money living on the edge of insolvency?

I’m mad at Wall Street. But I’m a lot madder at the people who gave them the keys to drive our economy off the cliff. I’m mad at the people who have taken hundreds of billions of taxpayer money and given it to some of the richest people in human history. I’m mad at Bush and Obama and Paulson and Geithner and Bernanke. And I’m mad at Congress. You made sure that risk-takers continue to expect that the rules that apply to the rest of us don’t apply to people with the right connections.

You have saved the system, but it’s not a system worth saving. It’s not capitalism but crony capitalism.

And therein lies the problem. If we were truly a capitalistic economy, the meltdown we experienced never would have happened because the banks, investment firms, and mortgage lenders would never have floated the amount of tainted paper that caused it all. They would have been prudent because they knew no one would bail them out, would get canned (without the golden parachute), and possibly go to prison. But the government intervened with “incentives”and gave them a license to be foolish, to push the edge of the envelope, and to waste money that wasn't theirs to begin with. They knew that if they lost it the government would bail them out, which means that we – the taxpayers – would ultimately foot the bill.

While a “pay” czar may sound like it would stop the insanity, it is merely window dressing that does nothing to solve the problem. Dictating what salaries and other perks high level executives will receive may be a sop to those calling for the government to “Do something!”, but it doesn't address the underlying cause of the problem: the government itself.

The regulations and laws passed by Congress that forced lending institutions to make loans to people unlikely to pay them back was merely one aspect of what led to the economy into a deep recession. Changes in lending practices at the behest of the government and government guarantees for sub-optimal loans merely added fuel to the fire that was the banking/credit and housing market collapse.

From what I've been hearing, seeing, and reading, Congress seems disinclined to actually do something substantive about it. They will make the appropriate noises, tell the media that they'll be tackling the issue(s), pass some legislation that sounds like it will take care of it but in the end will do very little to actually fix the problem, and then they'll move on to making sure they get re-elected in 2010.

Thus endeth the lesson.