Tyranny of the majority, 2009

James Madison must be spinning in his grave. Two hundred and twenty-two years ago, he was under the apparently-mistaken impression that establishing a republic would prevent the fatal flaw of democracy: inevitable suicide, via mob rule. That's what he was talking about in Federalist #10 — which I went back and reread after witnessing the embarrassing spectacle on Capitol Hill in the past week. 

Unfortunately, it's starting to look as if Madison was wrong; looks like it's possible that not even a republic is a good enough barrier against the tyranny of the majority.

Looks like guillotines on Capitol Hill could start going up any day now. Why? Two reasons:

(1) Because the people are so unanimously outraged about AIG bonuses they are demanding blood; and...

(2) The first rule for politicians and bureaucrats is to make sure everyone knows:

"Hey, THAT problem isn't MY fault, it's SOMEBODY ELSE'S fault!"

Of course it's an outrage that anyone got paid a bonus for collapsing the world's financial system. Never mind that our politicians could have prevented it from happening in the first place. Never mind that our government was the owner of the company that allowed those bonuses to be paid. Never mind that the politicians in charge of that government couldn't manage their way out of a wet paper bag. Never mind that our politicians' outrage didn't surface until the mob's outrage became apparent to them.

No, never mind all that, because our politicians know that the best way to "lead the people" is to find an angry mob, then run out in front of it and pass out a few more torches.

My view
I'm outraged, too. No, not just at a seriously flawed compensation system in private business that allows bonuses for disastrous performance. No, a much greater outrage to me is that, if we have any politicians at all who have a backbone, they are invisible and impotent. The only leader I saw stand up for the rule of law ("we can't just abrogate contracts") last Sunday morning was Larry Summers, but he got drowned out. Every other politician I saw, all the way to the top, was fanning the flames — reacting to the mob, instead of showing some backbone and taking responsibility.

Too bad for us, too bad for the rule of law, and too bad for James Madison's idea (the "republic") for preventing the tyranny of the majority from winning the day. We now know that, even if we do have a republic instead of mob-rule democracy, it takes leaders with backbones. Last week, they were in very, very short supply.

I wish more than just a tiny minority of our politicians understood the meaning of important concepts such as:

• ex post facto
• double jeopardy
• bills of attainder
• tyranny of the majority
• rule of law

But that's just wishful thinking, I guess. Oh well, it's not as if Madison didn't grasp the fundamental problem, or tell us about it in Federalist #10:

"Enlightened statesmen will not always be at the helm."

Comments

[Bob]

Pathetic,isn't it? These are not our brightest days.

Parading Liddy around was the epitome of disgraceful theater. They man is working for a buck a year trying to straighten out the mess. Heck, Id' want to make sure some key people didn't jump ship, too.

Are there any decent people in WDC?

[Mike H]

Am I misinformed that the bonuses did not go to people who screwed up and instead went to people that needed to wind down the problems at AIG and afterwords they would have no job? Meaning the bonus was the incentive to do a job that needed to be done but wasn't going to be there for very long?

[Optimist123]

Mike:

I don't know exactly who got the bonuses, and don't want to know (...even though Barney Frank wants them outed, presumably to make it that much easier for the mob to find them). I did hear that the division in question is the one that made big bets that the price of houses would go up forever and ever, amen. Even though some of the worker bees probably outperformed their individual goals and objectives enough to deserve bonuses, it's still guilt by association. In any case, we can be sure that compensation committees are scrambling to fix the problem (...I keep seeing suggestions about how to improve it every other day in the WSJ -- such as making bonuses a function of dividend payouts, among other ideas).

[Steve C]

The Patriot Act was pretty much the same thing. You just need to kill about 3000 people and the mob will clamor for the maximally unfree position, the only bulwark being the Supreme Court.

Even worse was the overnight rewrite of the Patriot Act just before the vote, which never was a big issue except for people who pay attention to these things.

OTOH, in this case, let's say the government (or the management put in place by the government) had said they just won't pay? Parties to contracts do this all the time, and of course if everyone did this all of the time our economic system would come crashing down.

But I don't see that there's a fundamental problem there - if you think the total benefits of violating a contract exceed the costs (including goodwill, etc), why is it anything but rational and in keeping with economic and legal principles to do so? The point has been made that it would have the additional advantage of forcing the execs to file suit in public.

And I wonder where the PR people were (maybe they all quit already). Just like when the auto execs arrived in Washington in corporate jets - a silly thing to criticize them for on efficiency grounds, but still you'd think they have people telling them how these things play with a public that wants blood.

[Bob]

Mike,

There are retention bonuses in play. Basically, you get x amount to stick around and help unwind things.

Let's say you're the new CEO brought in by the owners (in this case the government) to fix things. You're qualified to do so but don't know all the little details. You need people that know how things work in the firm. Can't just come in and fire everybody. What would you do?

BTW, this happens often in companies that are acquired. Key people are given some guarantees during a transition period.

Want to really get sick? Congress voted itself a 4.5% pay increase and they're not giving it back.

[Fat Man]

I had been trying to ignore Congress' feigned outrage* over the “bonuses” to AIG employees. To my way of thinking, it is like a three card monte game. Its real purpose is distract the marks while the card player's confederates pick their pockets.

The three card monte players are the politicians. The marks are, well, as the old gambler said: "If you don’t know who the mark is, it is you."

AIG was a conduit for over $170 billion to its counter-parties like Goldman Sachs. The “bonuses” were 1/10th of 1% of that amount, and, what is worse, 1/100th of 1% of the $1.8 trillion deficit that Congress is contemplating.

Keep your eye on the ball. While you are crawling around on your hands and knees looking for pennies, Congress has picked up T$ (i.e. tera-dollars as in units of a trillion dollars) and is preparing to make a bonfire with them.

“U.S. Federal Deficit Soars Past Previous Estimates” by Lori Montgomery, Washington Post Staff Writer on Friday, March 20, 2009:

"Deteriorating economic conditions will cause the federal deficit to soar past $1.8 trillion this year and leave the nation wallowing in a sea of red ink far deeper than the White House had previously estimated, congressional budget analysts said today.

"In a new report that provides the first independent analysis of President Obama’s budget request, the nonpartisan Congressional Budget Office predicted that the administration’s agenda would generate deficits averaging nearly $1 trillion a year over the next decade — $2.3 trillion more than the president predicted when he unveiled his spending plan just one month ago."

* My favorite being Chuck Grassley's suggestion that AIG's executives should commit suicide.

[Gil]

Will it be the Skeptical Pessimist from now on? Oh well.

On the other hand, you don't have go too far to find blogs where people would want to do what that image suggests and give the U.S.A. a reboot to 1776.

[Tom Hanna]

It would also be nice if people arguing the other side understood what it means for a company to be bankrupt. The first thing it means is that, yes, all the contracts are abrogated. Of course, AIG has never formally gone bankrupt, instead seeking and receiving a feeding at the public trough that is the real outrage that should have Madison spinning in his grave.

[Optimist123]

Gil:

I have never been optimistic about politicians in general, but have held out optimism that we could get the right things done in spite of them.

Tom:
"Let them fail" is a theme that has a lot of support, so you have a lot of company. But it's not specific enough for me.

One of government's few duties is to maintain the soundness of its currency; I recently reconfirmed that by rereading Adam Smith - Book 2, Chapter 2, of The Wealth of Nations. [The others are in Book 5: defense, justice, infrastructure, and education, by the way.] The idiots and crooks in AIG, much as I'd like to see them fail, are holding a dead man's switch connected to a financial nuke. It must be dismantled slowly and carefully. And, by now, almost everyone realizes (except for a few fringe holdouts) that letting Lehman fail turned out to have been a very bad idea.

That said, I'm with you on letting GM fail. Private sector manufacturing firms were definitely *not* on Adam Smith's short list of government's responsibilities.

[SkylightMT]

If the government can arbitrarily break any employee contract it wants with any agency in which it has a stake, no talent in its right mind would go to work for such agencies.

Which means all the talent will go to healthy agencies, and be motivated to keep them healthy.

This witchhunt, fickle as it may be, and misdirected as it may be, allows for a badly-needed release of steam in an economic environment where many people feel helpless.

I don't like the tyranny of the majority, either. But ignoring it won't make it go away, it will just lead to rioting.

What an incredible balancing act Obama has to perform. I'll bet he'd just like to focus on fixing things, and not have his attention diverted by trivialities that aren't going to matter one iota in the enormity of this crisis.

[Higgs Boson]

On 2/18/09 you wrote:

"...rescue wasn't an option, because the "rule of law" prevented it

What if Paulson and Bernanke had just kept the politicians out of it -- in order to prevent the "rule of law" system from (nearly) committing suicide? If that's what could have happened, should they have done it?

I cautiously say yes."

Now you write:

"The only leader I saw stand up for the rule of law ("we can't just abrogate contracts") last Sunday morning was Larry Summers, but he got drowned out.

...Too bad for us, too bad for the rule of law"

Let me see if I understand this. If a public official does something illegal, but it is something that you agree with, then it is ok to go ahead. On the other hand, if a public official does something illegal that you do not agree with, then it is mob rule.

[Optimist123]

Higgs:

You have a very large chip on your shoulder, so this isn't likely to do you any good, but I'll try again anyway. Feel free to parse each sentence below -- with your microscope if necessary -- and note any word, phrase, or complete sentence with which you disagree.

What I am against is the destruction of our economic and political system. Its foundation is the rule of law. However, sometimes the law is not clear, but officials must act quickly anyway, as Thomas Jefferson demonstrated. Occasionally when the law is not clear, survival of the rule-of-law system requires cautious trust in those officials who must make the important decisions quickly, before the rule-of-law system in effect commits suicide.

The Lehman decision was one of those occasions; armed with hindsight, most (but not all) experts now think the decision to let them fail was a mistake. There are Nobel prizewinners on both sides of that debate; Gary Becker, for example, still isn't sure, but leans in the direction of "let them fail." When Nobel prizewinners are on both sides of the issue even when armed with hindsight, with some still not sure, it tells me that the cocksure certainty you radiate is probably ill-advised.

Ensuring the soundness of the financial system is a duty of government, even in a pure laissez-faire system (see The Wealth of Nations, Book 2, Chapter 2). Adam Smith provided the tie-breaker, for me anyway: when in doubt, government must save the financial system. So much for the Lehman portion of your complaint.

The Capitol Hill frenzy last week is a no-brainer. Resorting to ex post facto laws, abusing the power of Congress (eg, Barney Frank's desire to expose AIG bonus recipients and their families to public lynch mobs), etc, etc, is not only the epitome of hypocrisy, it is, in and of itself, the destruction of the rule-of-law system.

And, as a reminder, I am against its destruction.

When you have parsed the above to your satisfaction, decide if you disagree with any portion of it. Then, if you feel like submitting another comment, try to leave the sarcasm behind, please.

[Nevadan]

Optimist - you are "outraged... at a seriously flawed compensation system in private business that allows bonuses for disastrous performance."

There is no such system. Disastrous performance in private business results in the doors closing.

What you're railing against is fascism, not private business.

[AlmostChosen]

Fantastic post, thank you.

[Tom Pearson]

Steve,
Post is spot on. Additionally --

The outrage should be directed at the Obama administration and the representatives in Congress that voted for the Bill. They approved the AIG bonuses. Senator Collins was aware that those AIG bonuses were in the bill and attempted to have them removed. She was rebuffed. Outrage should actually be directed at the current TALF and Treasury's plan to soak taxpayers for billions more by mis-pricing billions in bad paper.

[Tom Pearson]

TALF Bait and Switch
FYI.

http://zerohedge.blogspot.com/2009/03/amazing-talf-bait-and-switch.html

[clive999]

As predictions stand the national debt is set to reach $21 Trillion in 10 years, and GDP is set to shrink this year and maybe next year too, with unemployment set to exceed 10%
Given this and the likely collapse of GM and others,

what do you think is the likely required annual GDP growth needed over the next 10 years to mitigate the above bad news ??
Thanks
clive

[Optimist123]

Clive:

I think there's a substantial cushion between our current debt level and whatever level the tipping point might be. I also think that's fortunate, because we do need to use up a chunk of it to prevent a collapse, if a collapse is still preventable. That's the good news.

The bad news is, we're now using up that cushion at a record pace that is not sustainable. In other words, the only way out is for the economy to recover; stopping the spending won't work, increasing taxes won't work, only a return to confidence and economic activity will work. A few people think a return to normality will happen even if the government does nothing; I'm not in that group, because I think the expected cost of a collapse is too great to risk doing nothing.

In short, the debt level does not bother me; the stalled economy is what bothers me. That's why I wrote this article a few weeks ago:
http://tinyurl.com/b89hc9

[goy]

Dodd *openly lied* about his part in this. Has he been held accountable? No.

BHO and his pet media have deceitfully worked overtime to foment maximum populist rage toward AIG employees. Have they been held accountable for this in any way? No.

There was an opening in 2004 to send a message to the financial sector regarding the house of cards they were building on the foundation of ever-increasing real estate values. Congress had a chance, then, to impose rational regulation of the GSEs and the derivatives of the assets they were purchasing. They did not. They chose, instead, to continue purchasing votes by guaranteeing "affordable" mortgages, which now form the critical mass of 'toxic assets' that sent this train off the rails.

In failing to act rationally, Congress did two things. They gave their blessing to the notion that mortgage-backed securities were essentially 'riskless' (to use Raines' word) and they stated outright that any default related to the assets would be covered by the Treasury. Frank specifically made that promise during the hearings, sarcastically noting that it was business-as-usual for the federal government to cover for bad decisions.

Frank's view, obviously, was not in line with the notion that government should preserve the soundness of its currency, but that government should be robbing taxpayers to pay for risky benefits that translated to votes for him and his socialist ilk.

The problem is that Frank's glib prediction is precisely what has happened, but on a scale no one ever thought possible, let alone likely (or at least, fighting my cynical side, I'd like to think no one expected that, let alone worked to cause it).

This entire affair has been a desperate attempt to deflect attention away from the government's culpability in this failure - including Raines', Frank's, Waters' and others who ran interference for CRA and irrational GSE accounting practices. Those practices, and the government's blessing, signaled to the financial markets that all bets were acceptable and that the government would cover any losses. Have any of them been held accountable in any way for these economically suicidal decisions? No.

The problem is not just that there are no visible leaders (although McCotter has caught my eye). It's also this: a republic can't survive if its stewards engage in serial acts of corruption with impunity.

[Grodge]

OK, I guess I'm the only one who thinks the political process is working well.

1. The politicians had no other choice but to get out and lead the pitchfork wielding mob... here in the hinterlands I can tell you the outrage was *REAL* (even those in Washington and NYC referenced the death threats) and by dismissing it the politicians would have risked structural damage to the sausage maker we call republican govt. I would go so far as to say that pandering saved what shreds of confidence Joe Sixpack has in "the system."

2. We abrogate contracts ALL the time. Just ask any GM worker here in Michigan or anybody holding a non-recourse loan MBS. Couching the AIG bonuses in "protecting the currency" is disingenuous at best and only serves to flame the fire of discontent. No insurance company paper shuffler deserves 10X what a neurosurgeon makes. Ever.

Great blog, as usual. You are one of the few who takes on such topics from this point of view. Thanks.

[beancounter]

I've mentioned it before but I'll say it again because this post more than any deserves it: it is a *very* dangerous argument to make that the plebs are discontent enough to overthrow the government, because anyone intimately familiar with history can counter that there's a long way to go before a revolution and the mere risk of one doesn't warrant bailout/TARP/stimulus/any measures. Yours is certainly a more sound argument than a liberal one, but I could for example play devil's advocate and reply to your post "well politicians must give the circus its meat because by not we are risking a collapse so politicians should never take responsibility and the system is working as it should next time we will make sure it won't happen to begin with" etc., but I get the feeling from you Steve that you would be thrilled if Obama had taken responsibility and drawn the line, no ex post facto, no bills of attainder etc. What you fear is not a collapse Steve, but a *relapse* into the 1980's or 1950's or 1850's which puts you 180 degrees away from gold standard yokels.

You've said that your No. 1 priority is to ensure a high growth, low unemployment, low inflation economy for your grandchildren. Better to post about that IMO and keep this blog's namesake than to give the Higgs Bosons of the world a pulpit.

[Optimist123]

bc:

There's a big difference between an optimist and a pollyanna. I chose the former moniker for a reason (...way back five years ago when the fad was to think up a gimmicky name for one's new blog).

The most consistent and formidable challenge to my optimism has always come from politicians -- or, more specifically, from the things that have always motivated politicians. Last week's display of near-universal cowardice inside the beltway was too much for me, as you noticed.

What we need are statesmen; what we got last week wasn't statesmanship. Three years ago, I understated it this way: "Although statesmen must be good politicians, not all politicians are statesmen." (Article: "Where have all the statesmen gone?" -- link: http://tinyurl.com/dl5fkc )

I find myself missing Statesman #3 more and more as time goes on.

[beancounter]

Well if by Statesman 3 you mean Reagan's failure to live up to his promise to balance the budget (deliberately) while doing what he knew was right for the nation, I agree that this kind of statesman is missing. But that statesman better know what he's doing and it better be up there with thermonuclear war for a duly elected representative of the people to ignore the wishes of the people. Economic collapse may well be it.

P.S. Wealth of Nations is a strong supporter of a gold or silver standard. I am sure you have other sources to support the Federal government being responsible for the well-being of the currency, but perhaps using this source is not the best because it certainly violates the letter if not the spirit of the text. I am surprised none of the gold yokels have brought up this fact because you bring it up to every time someone mentions gold; shows them to rely on new age "libertarian" junk essays rather than source documents.

[Optimist123]

The Wealth of Nations was not about the gold or silver standard per se, it was about the nature of money, whatever a government chose to define as "money."

Adam Smith was a strong advocate of the government maintaining a stable value for its money -- whether the nation in question defined "money" as copper, silver, gold, paper, or seashells. (In Rome it was copper, in England it was silver, for example.) He also explained that when the mines produced too much of the metal in question relative to the nation's production of real goods & services, inflation was the result.

He was trying to correct the widespread misunderstanding of money. In short, his point was that money is not wealth; instead, the stuff money buys is wealth. When the quantity of "stuff" produced is able to grow, the supply of money must grow in order to support it. (Book 1, Chapter 11, Part 3: "When the annual produce of [a country's] labour becomes gradually greater and greater, a greater quantity of coin becomes necessary in order to circulate a greater quantity of commodities.")

Ironic, isn't it? Mr. Laissez-faire himself was an advocate of a growing money supply to support a growing economy.

[Mike H]

Steve and all,

Have you seen this?
http://tinyurl.com/c4hvmw

It's a perspective from one soon to be ex-AIG employee.

[Optimist123]

Thanks Mike; I had not seen that. I'm glad the other side of the issue is now coming out. But I did spot a couple interesting items in the WSJ (that topic, and the poker-with-China topic). An update article will be posted here at 3:01am central time tomorrow (Thursday).

[millhead]

This is one of the finer essays I have read on the current situation:

http://www.theatlantic.com/doc/200905/imf-advice

Written by a former IMFer, Simon Johnson, who has seen "similar" (used loosely as each country's problem was unique) financial situations with other countries.

What did the IMF consistently have to deal with? Breaking up the oligarchies and government cronies that fed off of one another. Sound familiar?

This essay pushes me over the edge to fully support the nationalization of some of the "bad" banks. I believe this is the quickest path to righting the financial ship. I'm just not sure BHO and his administration have the collective guts to take on Wall Street in the manner that would be necessary to make "nationalization" work. Especially with Frank/Dodd/Pelosi and company controlling the message on one side and Rush controlling the message on the other.