Sunday, December 4, 2011

The Fourth Directive of economic policy

The 1987 Peter Verhoeven dystopian science-fiction film Robocop concerns the adventures of the title character--a prototype cyborg law enforcement officer, constructed from the remains of a dead Detroit policeman by a giant consumer-products conglomerate, which was seeking to win a contract to replace the Motor City's police force, which was involved in a labor dispute with the city.  Robocop's activities were bound by three directives which he would mechanically repeat at public function:  Serve the public trust!  Protect the innocent!  Uphold the law!   Unbeknownst to most, including the conscious mind of Robocop himself, there was a fourth directive as well, and while the first three were arguably platitudes more than anything, the fourth was not:  do not arrest or harm any senior executive of Omni Consumer Products, the aforementioned corporation which was his creator. 

The movie was critically acclaimed (and a big box-office hit) and is highly recommended (its lame sequels are another matter).  However, the purpose of this post is not film criticism, but analogy.

Economic policymakers around the world, both in the US and (more recently) in the Eurozone, have various policy directives which guide their activities.  The Fed explicitly has a dual mandate to fight both unemployment and inflation, policymakers elsewhere are similarly charged.  Yet in many cases, including the current handling of the European debt crisis, policymakers at institutions such as the Fed and the ECB act as though they are guided by a "fourth directive" as well; and that fourth directive seems to be something along the lines of the following:

Do not do anything which will significantly harm the interests of capital.  

The various policy arms of the US government went to heroic lengths to bail out the financial markets, but seems far less interested in bailing out distressed homeowners.  Whether or not this is because the banks are really "too big to fail" (meaning their demise would truly produce systemic collapse), or simply too politically powerful to be allowed to fail, is an open question--but after programs such as TARP were enacted, it seems offensive to hear politicians tut-tutting about moral hazard when the subject is people losing their homes to foreclosure.

A similar scenario is now playing out in Europe, where the ECB seems intent in ensuring that the financial markets in the wealthy northern countries get their pounds of flesh, via imposition of stark austerity programs on the poorer southern Eurozone countries, programs which will likely result in a severe recession (on top of the current one), and may lead to the breakup of the Euro itself.  Granted, some of the debtor countries arguably went beyond their means and over-leveraged themselves to the point that an economic downturn left them unable to pay off their debts (Spain, Italy), and at least one debtor country could be fairly described as a deadbeat republic (that would be you, Greece).  The sanest course of action for European policymakers--insisting that the (mainly German) banks which made the bad loans in the first place take a haircut, combined with an injection of capital into the markets to protect depositors and refloat the Mediterranean economies, however, is simply not under consideration. 

Interestingly enough, the Fed last week announced a program to lend dollars at low rates to the ECB, in an attempt to stabilize European financial markets, a maneuver which prompts three questions:  1) The ECB is a sovereign currency issuer; why does it need to borrow money to fund its market operations, particularly when the bulk of the debt in question is denominated in Euros and not dollars?  2) Why is the US government being so activist in bailing out foreign financial markets?  3) And, particularly, if the answer to question #2 is "to prevent/limit recession", which is itself not unreasonable, then why is there so much reluctance to similarly intervene in the domestic economy, particularly on behalf of beleaguered consumers and underwater homeowners?

A likely answer to these three questions can be found within the fourth directive.


  1. Note that Spain was running surpluses before the Panic of 2008, which makes the "leveraging" description misleading. The overleveraging was in the private sector, not the government.

    When Germany imposed the policy in 2008 that the reaction to the financial crisis would be a nation at a time, that left Spain propping up a banking sector heavily invested in an unsustainable housing bubble ~ a housing bubble which Germans had profited handsomely from in the form of manufacturing exports to Spain, and which German banks had helped finance.

    Ireland had a trade surplus, and it was still lumped in with the PIIGS, given the combination of a housing bubble in its real estate sector and its dependence on cyclically sensitive corporate subsidiaries.

    Greece's public finance is and has long been fiscally unsustainable after it surrendered its status as a sovereign economy to join the Eurozone. But for the most part, the fiscal problem is structural: no Eurozone level fiscal authority with the political capacity or inclination to create the effective demand required left individual Eurozone states to pretend that they were still sovereign economies, despite the fact that they no longer had individual central banks able to stand behind their bonds in the currency of issue.

  2. Bruce, thanks for bringing up the case of Spain. Spain currently has a hard time dealing with the financial crisis because there are restrictions on the ability of their government to borrow money. There are also very few regulations on the mortgage industry.

    A lot of debts in Greece come from the Olympics and trying to conform to regulations that work in for northern Europe but not for the Greeks. Greece has never really benefitted much from being the European Union, and should never have joined the central currency.

  3. The people of Ireland were essentially forced into an austerity program to bail out private loans undertaken by their banking sector; not excessive public spending.

    But still--I find it amazing that sovereign governments continue to permit the financial sector to treat them like the neighborhood loan shark treats the junkies on the corner. Corporations default on debt all the time--including perfectly-solvent ones who default on secured debts as soon as the collateral is worth less than the balance--and it's considered business as usual. But let a state do it--or a guy with a mortgage--and moral panic ensues.


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