Keynes and the toxic asset valuation plan

I recently watched as Christina Romer, chairwoman of the White House Council of Economic Advisors, made the statement on CNN's State of the Union that the new plan to buy up toxic assets was an attempt to, “…help the taxpayer by using the expertise of the market by trying to set the price for these toxic assets…” In light of this idea and the resurgence in Keynesian economics, I found these passages from Keynes’ General Theory of Employment, Interest, and Money disturbingly relevant:

“It might have been supposed that competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, would correct the vagaries of the ignorant individual left to himself. It happens, however, that the energies and skill of the professional investor and speculator are mainly occupied otherwise. For most of these persons are, in fact, largely concerned, not with making superior long-term forecasts of the probably yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public. They are concerned, not with what an investment is really worth to a man who buys it 'for keeps', but with what the market will value it at, under the influence of mass psychology, three months or a year hence…Professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem form the same point of view. It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth, and higher degrees.” (Ch.12, Long-Term Expectation)

In their attempt to address toxic assets through a market-based valuation, I hope the government heeded Keynes’ observations and the current plan takes steps to prevent the distended speculation described above.

Dangerous Enthusiasm

I was looking at the Libertarian Party website this morning and I found myself beset by two opposing thoughts. First of all- damn the Libertarians sure do talk a good story. The emphasis on civil liberties, free market economics, and of course, limited government action is a proud stance that was certainly shared by those who founded this country, as well as many of us that inhabit it today. But my enthusiasm was dampened by a painful realization. Correct me if I'm wrong, but America doesn't seem ready for a Libertarian government. Ironically enough, the proof of this is found in the idea of Free Markets, the very ideological root of Libertarianism.

Free Market principles are quite simple in their basic form. An unregulated market will adjust prices, wages, and whatnot automatically. This idea was first presented by Adam Smith in An Inquiry into the Nature and Causes of the Wealth of Nations. This unfortunately titled book is large enough to double as a self-defense tool, yet the gist of it is simple enough: Don't Fight Self-Interest, Use It. Smith believed that all men are governed by self-interest. He also believed that one man's unyielding pursuit of what is best for him will be counter-acted by another man's similar interest. In essence, everyone is ruled by something like greed or ambition. But the danger of one man's ambition is neutralized by that of the next man. You can trust everyone only because you can trust no one. After millennia in which religions and philosophies sought different ways to make mankind virtuous, Smith finally realized that if one cannot stop mankind from being vice-ridden, perhaps one can redirect that vice to make it useful. Where Plato used Karate, Smith uses Jujitsu.

This general idea has come to govern everything from the very creation of our county (checks and balances, and the division of powers are based on this principle according to the Federalist Papers), to our adversarial legal system (attorney's argue for their clients, and only indirectly for the 'Truth' or 'Justice'). For over two hundred years the most important facets of our government and economy have been governed by Smith's basic idea. Our natural greed is the only proper tool for correcting market. Certainly there have been painful hiccups, and occasionally the proper way to act upon our natural self-interest is difficult to determine. But overall the great minds of our country, be they conservative or liberal, have generally ascribed to the belief that our greed can be used beneficially. It is a rare American politician that believes capitalism is fundamentally flawed, or that our legal system needs a fundamental redesign. Clearly the ideas that Libertarians advocate are based upon commonly accepted principles of human behavior. That is not the problem. The problem is timing and starting points. My fundamental problem with Libertarianism can be demonstrated in many elements of their political platform. For ease of understanding I have chosen the Libertarian stance on 'Economic Liberty' as an illuminating example.

Among the many admirable proclamations found on the Libertarian Party website (http://www.lp.org/) is the following segment describing their party platform regarding economics:

“2.0 Economic Liberty
A free and competitive market allocates resources in the most efficient manner. Each person has the right to offer goods and services to others on the free market. The only proper role of government in the economic realm is to protect property rights, adjudicate disputes, and provide a legal framework in which voluntary trade is protected. All efforts by government to redistribute wealth, or to control or manage trade, are improper in a free society.”

Take special note of the last sentence, as this is where they have gone wrong. One of the inescapable facets of Adam Smith's basic idea of capitalism is that the proper functioning of free markets requires certain things. The individuals participating in the market must have the most perfect information possible and they must be as free to adapt financially (alter careers or investments). The equation is simple: less information or less financial mobility equals a less efficient capitalism. The converse is also quite simple: more information or more mobility and the market will self-correct more efficiently.

The problem with the Libertarian platform is that it fails to recognize that different Americans are born into different levels of information and mobility. It is still quite possible for a modern day Einstein to live, work and die unnoticed simply because he came from a poor family, or he lived in a neighborhood with a mediocre public school system. My understanding of Libertarians is that they want the world to be a true meritocracy with people getting what they deserve. The lives of most of people are determined by unnatural advantages. Anyone who cares to notice will have seen stupid, lazy people go to Ivy League universities because their parents made a well-timed donation. It is equally common to see truly brilliant, hardworking people fail to impact the world because they lacked the necessary money or contacts.

Perhaps if we had begun our civilization with a more Libertarian outlook we would not have these problems, but the simple fact is that these problems exist and cannot be fixed by adopting Libertarianism now. Rather than jumping in immediately, we must prepare the ground. The Libertarianism that I would vote for is one that proceeds slowly and carefully. It would be a Libertarianism that works to fix the inequalities we have created for over two hundred years as a necessary prerequisite. Let me be clear, once we live in a country where you succeed based solely on hard work and intelligence, Libertarianism will be the best possible plan. But until then it seems destined to exacerbate the mistakes of the past by ignoring them.