Political philosophy and the Paulson plan, a dialogue

by Chris Bertram on September 27, 2008

Pancho: So what does political philosophy have to say about the banking crisis?

Lefty: Excuse me?

Pancho: Well, millions ruined, pensions and savings binned, an appeal to taxpayers to save the banks? It all seems rather, um, well distributive… I’d have thought you could give us some policy advice?

Lefty: Well I don’t really do that kind of thing, I do ideal theory.

Pancho: What’s that when it’s at home?

Lefty: I’m mainly concerned with devising optimal principles of social regulation under conditions of strict compliance, this is far too messy for me …

Pancho: Go on, have a go!

Lefty: OK well, since you insist …. Luck egalitarianism might be a good starting point.

Pancho: What’s that then?

Lefty: Luck egalitarianism is, roughly, that differences in how people fare should be consequences of their choices rather than their unchosen circumstances. People who get dealt brute bad luck have a claim not suffer on that account; whereas people who knowingly take risky gambles had better live with the consequences, whatever they turn out to be.

Pancho: Those bankers are screwed then! (And lots of other people too.)

B. Well not necessarily. Like I said, a lot of this stuff relates somewhat problematically to the “real world”. That’s because the choices people make in this actual world aren’t made against a background of equal resource endowments, and the inequality of those endowments may undermine the autonomy of people’s choices, and hence the extent to which we can reasonably hold them responsible. To put it bluntly, it reeks of bad faith to hold a poor and poorly educated person entirely responsible for that part of their fate that results from their choices, given the way in which their capacity to choose has been shaped by poverty and a poor education.

Pancho: That was a bit long-winded! Nevertheless it still leaves the bankers screwed. They had had the benefits of wealth, good education, and, indeed, special training in evaluating the riskiness of their choices. If anyone, in the history of the world, can be held responsible for these sorts of decisions, these people can be. There’s less brute luck and more option luck here, than anywhere else apart from an actual casino, ever!

Lefty: Other people affected by the crisis made choices too. They took out mortgages, and maybe they lied about their incomes. To some extent, they too are responsible.

Pancho: But they aren’t as responsible: they didn’t (typically) have the same wealth, education, and special training. They were also, to some extent, the prey of people who wanted to sell them financial products and who almost certainly exploited their weaknesses. They can’t be held as responsible as the banks, companies and their executives.

Lefty: Yes. So if luck egalitarianism gives an accurate account of what justice requires (and that’s a pretty big if), Wall Street should be allowed to fail and Main Street should be given a little bit of love (but not too much).

Pancho: I’m glad we sorted this out. So political philosophers are against throwing taxpayers’ money at bankers, and support measures to keep people in their homes ….

Lefty: Not so fast. Maybe the little people will be worse off if we do that because the whole system will collapse. Maybe, to save the system, we need to throw lots of money at the people who made the bad choices ……

Pancho: But you said ….

Lefty: I know, but there’s this thing called the difference principle.

Pancho: What’s that then?

Lefty: Well it says that we should arrange the way our society works so as to give the least advantaged people the best prospects they can have …. it’s kind of hard to apply it in the middle of a crisis, but it might justify something like the Paulson plan, if that’s what it took ….

Pancho: I have my doubts, how can it be in the best interest of the least advantaged to throw money at the guys who made the bad decisions? Won’t they just make risky choices again, and land us all in a similar mess in a decade or two?

Lefty: Maybe. But let’s assume it is true (we do a lot of that) that throwing money at the bankers is in the long-term interest of the least advantaged, because that’s what’s necessary to save the system.

Pancho: Assume away … you usually do ….

Lefty: Well then, the difference principle says that justice requires the Paulson plan.

Pancho: What? But that’s crazy!

Lefty: Sometimes philosophy makes counterintuitive recommendations ……

Pancho: Hang on, I remember having a conversation with you a couple of years back ….

Lefty: Oh yeah?

Pancho: Yes, then you were saying that we ought to pay large salaries to bankers and top executives because that would end up being in the best interests of the least advantaged …..

Lefty: I did?

Pancho: Yes, you said egalitarian justice required that too ….

Lefty: Well what justice requires is a complicated function of abstract principles, explanatory theory and empirical data ….

Pancho: Bullshit!

Lefty: Try to remain civil!

Pancho: Back then, financial guys said that if we didn’t pay them the money then they wouldn’t do all their ninja-financial things and everyone would be worse off. I said, if you recall, that that was a bit like saying “hand over the cash or the kid gets it”.

Lefty: Yes, there was a guy called Cohen who said the difference principle was a bit like that ….

Pancho: Sounds like a stand-up guy!

Lefty: Yes, but I explained that justice wasn’t about personal choices but about the shape of the institutional structure ….

Pancho: You’re losing me …. Anyway, it sounds like those guys are saying “hand over the cash or the kid gets it!” all over again!

Lefty: That’s pretty much the size of it.

Pancho: Well sometimes, in a situation like that, you have to pay up, but it’s got nothing to do with justice in my book.

Lefty: I think I may be coming round to that view myself.

{ 35 comments }

1

John Emerson 09.27.08 at 4:46 pm

Tom and Daisy always win in the end.

2

almostinfamous 09.27.08 at 5:25 pm

wait, isn’t the kid their(wall street’s) kid too?

like wall street is the abusive father, and the taxpayers the abused mother. the economy is the dysfunctional kid caught in the middle of a dysfunctional family?

3

J— 09.27.08 at 6:01 pm

It should be noted that currently Lefty’s living in a cheap hotel.

4

geo 09.27.08 at 6:29 pm

Congratulations on a wise and delightful post, Chris. No practical disagreements, but a question about the premise of luck egalitarianism. I agree entirely that

the choices people make in this actual world aren’t made against a background of equal resource endowments, and the inequality of those endowments may undermine the autonomy of people’s choices, and hence the extent to which we can reasonably hold them responsible. To put it bluntly, it reeks of bad faith to hold a poor and poorly educated person entirely responsible for that part of their fate that results from their choices, given the way in which their capacity to choose has been shaped by poverty and a poor education.

But shouldn’t “resource endowments” be extended to included genetic (eg, neurochemical) endowments, which, at least arguably, shape character and temperament as much as education and other contingencies? And if so, then what becomes of “choice”? Isn’t it, as William James said of free will, a “fifth wheel to the coach”?

A down-home example: from my raised-during-the-Great-Depression, one-generation-removed-from-Southern-Italian-peasant parents, I seem to have inherited the extreme aversion to risk that was manifest in every aspect of their lives. They wouldn’t even put their savings in a bank, much less the stock market (which, of course, soared during their lifetimes). Instead, they rolled up the bills and stuck them in the hollow legs of metal chairs. I’m not sure this entitles me to an equal share of every dashing entrepreneur’s or venture capitalist buccaneer’s pile. But it does seem to undercut the standard free-market justification for extreme inequality of wealth.

5

HH 09.27.08 at 6:31 pm

Financial panics are the cyclical result of unsustainable local optimizations. Every malefactor believes that he will be able to grab the last bag of loot and make a getaway. The severity of crashes and panics is a function of the size of the economy and the ability of crooked players to conceal their moves. Both have increased substantially in the US in recent years.

The stubborn refusal of contemporary ideologues to properly orient the controversy in terms of the poles of truth and falsehood continues to obscure the problem and impede remedies. Because we have clothed lies in the noble robes of “spin,” we are unwilling to restore sovereignty to truth. The economic pain will continue until the lying stops.

6

novakant 09.27.08 at 6:48 pm

This “luck egalitarianism” seems philosophically rather shallow to me, unless it is supported by a theory of free will and decision making processes. I grant, that it allows for external factors to shape our decisions to an extent, but nevertheless free will is simply presupposed and what actually happens in the process of making a decision not further investigated.

“Luck egalitarianism” also seems to be a rather conservative theory: risk taking is penalized, playing it safe rewarded. Reminds me a bit of the authoritarian father in Dead Poet’s Society, who pressures his son into studying medicine, instead of letting him realize his dream of becoming an actor.

7

Canadian 09.27.08 at 6:50 pm

An alternative principle? Democrats have not met a bailout that they do not like.

8

harry b 09.27.08 at 7:08 pm

novakant; no, the whole point is to reward successful risk-taking, where risk-taking it deliberate and done against a background of equal opportunity. And, of course, to penalise failed risk taking of the same kind (unlike the Paulsen plan, which rewards risk taking whether successful or not). Also, luck egalitarians are (almost all) pluralists –LE is just one of many values or principles, to be weighed against others.

It is not exactly philosophically shallow — but I see why you think that. What it does is states a distributive principle, while leaving open the theory of responsibility (whatever your theory of responsibility you might, or might not, endorse LE).

9

abb1 09.27.08 at 7:38 pm

Sounds like it’s not “against a background of equal opportunity”, but rather something like ‘risk-taking normalized by the amount of resources available’.

Geo, just wait, be patient. Blessed are the meek, for they will inherit the land.

10

novakant 09.27.08 at 7:51 pm

Harry, why should we “reward successful risk-taking”? People who took a risk and succeeded are already being rewarded by society with money and status. Yet, the concept of risk entails that only a certain percentage succeed, while others fail, else it wouldn’t be a risk. Those who fail are already being penalized by society with lack of money and status. When you talk about penalising failed risk, do you mean we should punish them even more?

And all that is only speaking with hindsight, the concept of risk further entails that one cannot foresee the outcome, otherwise there wouldn’t be a risk. If somebody embarks on an acting career or starts a company, he cannot know if he’s good enough or if his business idea will take off – and even if he shows great talent or has a great business plan, there is a good amount of luck involved in determining the outcome. Of course we can tell people to minimize that risk, but a society cannot be made up solely of, say, accountants and pharmacists.

Don’t get me wrong, I don’t like finance big shots operating in a risk free zone, because they have guaranteed multi-million retirement packages. And I think it’s a good idea to steer regular people towards behaving responsibly in financial matters. But as a general principle, I don’t think “luck egalitarianism” holds up.

11

Chris Bertram 09.27.08 at 8:41 pm

Hmm, I’m not sure that you and Harry are understanding one another well here novakant. LE certainly says that when people knowingly and deliberately take a risk and it pays off then they should be allowed to profit, and that when it does not they should bear the loss. It just expresses the liberal presumption that people should get to make their own lives as they choose and couples it with the notion that no-one has a prior right to a differential advantage in life-making over anyone else. It doesn’t say that risk taking is good in itself, nor that some mysterious additional rewards or penalties should be imposed.

(Btw, by all means go ahead and have a deep discussion about LE, but my post was not intended to provoke one.)

12

Chris Bertram 09.27.08 at 8:43 pm

Oh and it doesn’t say, “choose medicine rather than being an actor”, it says “choose the career you want, if it works out, fine, if it doesn’t, don’t expect others to bail you out.”

13

harry b 09.27.08 at 8:44 pm

LE is a pre-institutional principle; ie, it is supposed to guide the design of institutions, so no, no “extra” reward beyond that which the (correctly designed) institutions provide. My point was just that it doesn’t encourage hihg levels of risk aversion. There’s a standard distinction in the literature between “option” luck — that is, when the decision was made knowing roughly what the probabilities usually are (or something like that) (eg, stock market risk) and where, therefore, responsibility can be attributed; and “brute” luck, when the bad (or good) outcome comes out of the blue (being born to a rich family; being struck by lightning). Most LEs says that inequalities that are generated by option luck are ok; inequalities generated by brute luck are not. Don’t ask me to elaborate further or defend the distinction (I don’t have time for the former, and can’t do the latter, but I bet someone can).

14

novakant 09.27.08 at 10:10 pm

LE certainly says that when people knowingly and deliberately take a risk and it pays off then they should be allowed to profit, and that when it does not they should bear the loss. (…) choose the career you want, if it works out, fine, if it doesn’t, don’t expect others to bail you out.

But as I have pointed out above, that’s how capitalist societies on a base level work anyway – winners win, losers lose and nobody cares – and I don’t see what LE adds to that. I also don’t see how this is supposed to be a theory of the left, instead it’s a rather disjointed mix of levelling the playing field and social darwinism, and while we haven’t fully achieved the former, I’m certainly glad we have overcome the latter.

15

Chris Bertram 09.27.08 at 10:26 pm

_I don’t see what LE adds to that_

It adds compensation for unchosen disadvantage, whereas naked capitalism _amplifies_ the effects of unchosen disadvantage. I can see what you mean by “social darwinism” here, but I think the connotations are misplaced. After all LE doesn’t say that a poor actor is, in any sense inferior to a rich medic, just that the latter doesn’t owe the former any support.

16

Slocum 09.28.08 at 11:37 am

The problem with this ‘bankers vs ordinary people’ analysis, is that there are really two groups of ordinary people of interest here. Let us call these two groups the ‘grasshoppers’ and the ‘ants’. The grasshoppers seem to be the only ones our esteemed political philosopher can see, but the ants are there nonetheless there (and are actually many times more common than the grasshoppers). The ants certainly do resent being called upon to bail out the bankers, but they equally resent being called on the rescue the grasshoppers…

17

John Emerson 09.28.08 at 12:06 pm

The ants resent rescuing grasshoppers much, much more, because high finance is mysterious and distant, whereas ordinary ants always have some kind of personal contact with ordinary grasshoppers and hat them hate (to say nothing of anecdotal welfare mothers). And plenty of ordinary ants get sucked into financial rackets, because they are often susceptible to magical thinking about finance and business. (Of course, ants are highly competitive, and besides welfare mothers they also hate unlucky loser ants).

House Republicans are spinning this as a welfare mother problem, but that’s because they love capitalism but understand it even less well than I do. (Here’s Yglesias on the House Republican’s fearless leader.)

18

abb1 09.28.08 at 2:04 pm

It’s the Ant and the Dragonfly, as far as I am concerned.

19

Timothy Burke 09.28.08 at 2:40 pm

Two things complicate this further. First, the bankers at the top of the system knew that no matter how seemingly risky their choices, the institutions that they were committing to risk could not be allowed to fail at a level consistent with the risk being taken. Ergo, what they were doing was not risky. This is pretty much where ‘moral hazard’ enters the picture.

Second, the problem is that there so many layers of distributed risk here that deciding who took the riskiest choices and should suffer the most intense consequences is somewhat difficult. Is it really, for example, the executives who agreed to the purchase of rebundled toxic debts? The traders who bundled those debts in the first place? The guys who sold the subprime mortgages in the first place? The latter group in some sense ’caused’ this, but actually they probably understood perfectly well where the money to be made in doing so was: in the first three to four years of massively disproportionate interest rates, at which time this stuff could be all bundled and passed on to someone else who would get stuck with the foreclosers. Maybe it’s the deregulatory policy makers and lax oversight bureaucrats who took the real risk. Maybe it’s the majority that elected the people who took the risk. Deciding who has agency in taking risk pretty much confounds idealized liberal individualism.

20

LFC 09.28.08 at 2:53 pm

Slocum @16: the ants are “many times more common than the grasshoppers”
If by “grasshoppers” you mean people with a direct stake in the U.S. stock market’s ups & downs, keep in mind that that (for better or worse) is a very large number of people (given pension funds invested in the market, etc.). I don’t know the exact figures, but I wouldn’t be surprised if 50% of more of the population are “grasshoppers” in this sense. Of course some grasshoppers have a lot more than others; I’m certainly not defending the high levels of income and wealth inequality in the US, just making a factual point.

21

abb1 09.28.08 at 3:12 pm

What Timothy said. The institutions worked exactly the way they were supposed to work. The economy was in trouble and the Fed lowered the interest rates, just as it was supposed to. People started refinancing and buying – just as they were supposed to react to low interest rates. The banks facilitated this activity and profited from it, just like they should. There is really no individual or a group of individuals to blame here, everything worked like a clockwork.

Don’t like it? Change the system. Satisfied with the system? Wind it up (by the bailout) and keep going.

22

congal 09.28.08 at 3:56 pm

When what’s being “risked” is other people’s money, doesn’t the word lose any meaning in this context? If we define risk as some potential for those making the risky decisions to incur some loss, then the one thing the current version of Wall Street has managed to avoid almost entirely is risk. Forgive me for getting all anecdotal, but I know several men and women who worked on Wall Street (“worked” because they are all retired in their 50’s with tidy, low and high 6- and 7-figure nest eggs) and not a one of them ever risked a single dollar of their own money. They garnered enormous fees, commissions, salaries and breathtaking bonuses, and when they invested their own money it was in the surest of things informed by the surest of insider information (a dirty not-so-secret on Wall Street). They and their bosses were never, ever, concerned with long-term risk for themselves or their institutions, but immediate profits there for the taking, and who on earth was going to stop them, or even convince them to do otherwise? Regulators? Warren Buffet? The investors and instutions whose money fueled their gambling addiction were ones taking the risk, not Wall Street.

23

Chris Bertram 09.28.08 at 4:23 pm

_the problem is that there so many layers of distributed risk here that deciding who took the riskiest choices and should suffer the most intense consequences is somewhat difficult._

Er no, I don’t think so. To know that a gambler should be held responsible for the outcomes of his or her gambles, we don’t need to know anything about how risky those gambles were, just that the gambler went into the transaction with his or her eyes open, wasn’t suffering from an OCD, etc.

24

novakant 09.28.08 at 5:45 pm

It adds compensation for unchosen disadvantage, whereas naked capitalism amplifies the effects of unchosen disadvantage.

Yeah, but I don’t need LE for that, it adds nothing new or interesting, efforts to level the playing field have been around for a long time , both on a theoretical and a policy level.

LE doesn’t say that a poor actor is, in any sense inferior to a rich medic, just that the latter doesn’t owe the former any support.

But in mixed economies the rich medic does bail out the poor actor, not directly, but indirectly through progressive taxation, welfare programs, subsidized education, public funding of arts programs etc. .

25

Chris Bertram 09.28.08 at 6:51 pm

#24 Dworkin would claim, I think, that his incarnation of LE (though, confusingly, he denies being one) offers the best philosophical justification both for the “levelling” you favour and for progressive taxation etc. (Just saying, that’s not an endorsement by me either of Dworkin or LE.)

26

virgil xenophon 09.29.08 at 2:44 am

What both Timothy and abb1 said!

27

virgil xenophon 09.29.08 at 2:52 am

And congal too, for that matter. The “rules of the game” allowed them to do so. pure and simple. To not do so and forsake tons of money for the sake of the mere “possibility” of a meltdown at some nebulous point in the future would have been totally irrational–from where they sat. No hair-shirts on Wall Street.

28

Jacob T. Levy 09.29.08 at 3:01 am

Dworkin would claim, I think, that his incarnation of LE (though, confusingly, he denies being one)

Yes, I’m confused by that. Could someone explain it to me?

29

bryan 09.29.08 at 3:14 am

Lefty: Maybe. But let’s assume it is true (we do a lot of that) that throwing money at the bankers is in the long-term interest of the least advantaged, because that’s what’s necessary to save the system.

I’m not sure that something’s “being necessary to save the system” makes a convincing argument that it’s in the interest of the least advantaged, given that the system being saved is the one that provided them with the least advantages.

30

dan 09.29.08 at 3:23 am

What Timothy said. The institutions worked exactly the way they were supposed to work. The economy was in trouble and the Fed lowered the interest rates, just as it was supposed to. People started refinancing and buying – just as they were supposed to react to low interest rates. The banks facilitated this activity and profited from it, just like they should. There is really no individual or a group of individuals to blame here, everything worked like a clockwork.

Don’t like it? Change the system.

Ridiculous. It’s a system that was created by individuals and groups of individuals, for the benefit of said individuals and groups of individuals, so said individuals are utterly to blame.

31

Righteous Bubba 09.29.08 at 3:40 am

A sad story.

Parkes, 44, has an IQ of 56 and the math skills of a first-grader. Sakry is 43 and, like Parkes, faces challenges when it comes to planning and maintaining budgets. Despite their limitations, three different lenders persuaded them to keep refinancing their home until they burned up the equity in their house and could no longer afford the payments.

32

J Thomas 09.29.08 at 6:28 am

“Don’t like it? Change the system.”

Ridiculous. It’s a system that was created by individuals and groups of individuals, for the benefit of said individuals and groups of individuals, so said individuals are utterly to blame.

In general the people who design a casino are not the people who gamble in it.

But to my mind the question how to design a workable system is separate from the question how to punish the people who created and operated the bad system.

I’d like to see a way to take their ill-gotten gains from them, but that’s tricky. You can’t prosecute them for things that weren’t illegal when they did them — it’s in the Constitution. To some extent we have to let them get away; they are a side-effect of letting Bush be president.

But we really need a new system. I would suggest first a new stock market, run by the US government as a non-profit. The Treasury keeps the money in a Treasury money-market account. The market keeps open books — anybody can look at the open limit orders. No naked short selling, no short selling at all except by explicit agreement between stockholders. Let stockholders choose which exchange will keep their stock; if the federal stock market has problems they can use another exchange. But they get a tax advantage for using the federal one…. It might be a good place to put retirement money. No brokers, no brokers fees, you can hire a broker to do market analysis etc but you don’t have to.

Second, require the largest corporations to split up. Anything that’s TBTF is too big. Some people argue that economy of scale makes it worth having them that big. But TBTF is a bigger diseconomy than any efficiency they could get from their size.

If we make the largest companies split up we’ll have to do something about insurance. Insurance companies are all about economy of scale. If they get too small they stop working. Maybe the government could do the more common insurance tasks? For a reasonable profit?

33

Tracy W 09.29.08 at 8:03 am

The severity of crashes and panics is a function of the size of the economy and the ability of crooked players to conceal their moves. Both have increased substantially in the US in recent years.

How do you know this? After all, if crooked players are getting better at concealing their moves, they should appear more and more like honest players (or alternatively like people who aren’t playing at all). Which makes it difficult to figure out if dishonesty has increased or decreased.

Also, what is your evidence that the severity of crashes and pancis is a function of the size of the economy? I understand from economic historians that the 19th century, when any country’s economy was much smaller (with possible exceptions being countries like Zimbabwae and North Korea), crashes and panics were more common than they have been in the 20th century. The 1890s depression has been estimated at worse than the 1930s depression, though the statistics from that time are not as good. See for example http://en.wikipedia.org/wiki/Category:19th_century_in_economics for a list of panics in the 19th century (very US-focused, sadly).

34

Aethelbald 09.29.08 at 8:54 am

@Timothy Burke:

“deciding who took the riskiest choices and should suffer the most intense consequences is somewhat difficult”

The rating agencies who once rated CDOs as AAA and then, within a week in some cases, dropped their rating to junk might not be too difficult. How could they have been so wrong and still they prosper? Their conflicts of interest appear to be relevant.

Also, why is it legal to write insurance that guarantees your own debts? (Credit Default Swaps) You don’t have to be Warren Buffett to see that activity of that sort should be illegal. It is an example of regulatory failure where the heads that should roll are probably easily identifiable.

35

NPOV 09.29.08 at 10:03 am

“financial guys said that if we didn’t pay them the money then they wouldn’t do all their ninja-financial things and everyone would be worse off”

Did or does anyone seriously take any notice of such claims? It’s one thing to believe that a certain percentage of talented investors/ speculators out there would get out of the game if there was less profit in it, but quite another to believe that nobody else would step in and be just as effective as helping a nation grow its wealth.

You only need to look at Warren Buffet – arguably the most successful investor and wealth-creator ever, for whom large personal financial gain is quite obviously not his primary motivation (his regular salary is something like $100K).

Oh and regarding the “to big to fail” problem – how about instead of forcibly breaking them up, simply requiring part nationalisation of companies over a certain size? If they wish to avoid nationalisation, they are free to break up their operations as they see fit.

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