Rewarding Failure, at Our Expense

Many middle-class Americans are outraged by the bonuses Goldman
Sachs is paying its top traders. The corporate media treat such outrage
as "populist" irrationality or simple envy. CNBC's anchors worry that
curbing bonuses will undermine banks' ability to do their jobs and
thereby slow the recovery.

These worries are misplaced. The risks to long-term recovery lie in
the continuing failure of Congress and the media to understand the role
that investment banks played in the crisis.

The accusation of envy is especially misplaced. As a culture,
Americans are extraordinarily enamored of the wealthy. The American
dream is to become rich rather than to tax the rich. State lotteries
reflect and feed these dreams. Redistributive taxes always have a hard
sell in this country and can prevail only under relatively dire
circumstances - often aided by the malfeasance of the rich.

The
ethical case for taxing or limiting bonuses is not based on some
abstract understanding of the tolerable level of social inequality.
CNBC reminds its listeners that the banks have repaid their TARP funds
and are therefore entitled to their profits.

These claims rely on considerable historical amnesia. Direct TARP
subsidies to the banks were only the most visible favors from the
Treasury and the Federal Reserve chief. Among the favors were an
extension of deposit insurance to their money market funds and
extending to these investment banks the right to the same kind of
low-interest loans from the Fed available to community banks.

And all of this support was provided without the usual standards
imposed on local banks. The large investment banks operate under
continuing too-big-to-fail protection and with low-interest financing.
Not surprising in an economy where many assets are depressed, they have
been in a position to reap speculative albeit risky (to us) profits.

The favorable treatment investment banks receive from government and
the media becomes even more apparent when we think back to the auto
bailout. Government and the media had no trouble demanding draconian
reductions in autoworkers' contractually guaranteed wages and were
scrupulous in tracing every dollar or favor extended by the government.
Do you think a long-term loan at less than 1 percent to GM guaranteed
by the Fed would not have elicited intense media scrutiny?

The scrutiny of autoworkers reflects not only a bias against the
working class but perhaps even disrespect of those who actually make
something. In the years leading up to the bursting of the tech bubble,
pundits, even on the left, suggested America's economic future depended
on "symbolic analysts" replacing all those manufacturing jobs. Even
after that dream collapsed amidst the rubble of high-tech startups with
no visible means of profitability, we continue to hear about the
contributions that "innovative finance" makes to economic progress. All
those surplus computers would have a new use.

But what has financial speculation brought us? Derivatives so
complicated that even their creators can't untangle them tops the list.
These innovations contributed to the housing bubble and also brought
much of our financial system to the brink of collapse. But even before
its collapse, economic growth in the U.S. was exceptionally slow.

So I am all in favor of reducing incentives to innovate in the world
of high finance. A so-called Tobin tax, a small tax on the purchase and
sale of financial assets is crucial. It discourages frequent
speculative trading

but has little effect on long-term investment or garden-variety
hedges against energy price increases. More broadly we need to look at
the whole role of investment banking.

James Galbraith points out that U.S. economic growth was stronger
and more sustainable when banking was plain vanilla. Banks accepted
deposits and made loans to credit-worthy businesses and households. He
reminds us that China limits banks to that role and even restricts the
role of equity markets in corporate governance. Though Galbraith and
most progressives would not claim China as any model - indeed the
romance of an ideal, from the Soviets to Sweden to Japan to China, has
long produced misery for the left - its experience does challenge our
certainties about the role of deregulated financial innovation.
Limiting not only the amount but also the structuring and source of
bonuses is both ethically and economically warranted.