Posner: Two Conceptions of Blame (Part 1)

A few readers have asked us for our thoughts on Richard Posner’s recent writings on the economic crisis, beginning with his new book and continuing with his epic blogging for The Atlantic. (To read his account from the beginning you need to find the well-hidden Archives section in the right-hand sidebar of the blog.) The challenge is that every time I try to catch up Posner has written another couple of thousand words. So I’m going to have to do this in pieces.

Posner is a giant of legal scholarship and in the theoretical branch of law and economics, which (judging from my own education) is the dominant paradigm for several fields of law, including torts and contracts. To simplify his importance greatly, he helped shift the legal profession, including both the academy and the courts, from a focus on justice – law should redress the harm suffered by the victim – to a focus on incentives – law should create incentives that will produce the greatest good for society in the future. For example, in general, firms should only be held liable for injuries they negligently cause if the expected total damages they cause exceed the cost of preventing those injuries; if we require firms to conduct inspections whose cost exceeds the cost of the injuries that those inspections would prevent, then we are reducing aggregate utility.

As you might guess, Posner is also generally a pragmatic conservative, who thinks that free markets usually lead to better societal outcomes than government intervention, and that public policy should focus on making sure that independent rational actors have the right incentives to behave in ways that will benefit society as a whole. Not surprisingly, his account of the crisis focuses not on the actions of people in the financial industry but on the failings of people in government.

From his May 5 post:

The government has conveyed to business and the public the message, which misunderstands the causes of the economic crisis, that “Wall Street” should be blamed (or China too, as Geithner once suggested) and must be punished. This hostility and air of menace make financial firms reluctant to get into or stay in bed with the government, and thus impede the bailout efforts. . . . In fact the major culprits in our present economic distress are government officials, such as Alan Greenspan, and academic economists, but they are getting off lightly, because they are obscure and there is more political mileage in denouncing “Wall Street.” How many Americans actually know who Alan Greenspan is, or what a macroeconomist is?

Now, I have also written that if you want to blame one person, then Alan Greenspan is your guy – because, of all the people who could have helped prevent or mitigate the crisis, he was the most important. But I also think that “Wall Street” – or various actors in the financial sector – should be blamed.

There are two different senses of “blame,” and Posner – true to his decades of scholarship – focuses only on one. His approach to law and policy is thoroughly utilitarian. The question you always ask, reading his opinions, is what incentives this decision will create for firms and individuals, and how their behavior will change in the future. Moral blameworthiness does not enter the equation. For example, Posner is a famous proponent of the “efficient breach:” the idea that if you find a better use for your goods than honoring a contract, you should breach the contract, as long as you are prepared to pay damages to the party you have injured. According to Posner, this maximizes social utility (measured in dollars and cents). (Incidentally, not all legal scholars agree – it depends on how your measure transaction costs.)

Posner does not care about moral blameworthiness; insofar as fault is concerned, he only cares about causation. And from that standpoint, no individual Wall Street executive is a necessary part of the chain of causation that produced the crisis; if he had walked away in disgust, someone else would have taken his place and done the exact same thing. (Greenspan, by contrast, could have changed things, had he so chosen.)

From that standpoint, if you want to focus on how the system should change in the future, it makes sense to look at what government can do and not at what individuals in the financial sector should do. If mortgage brokers cut corners and investment banks marketed toxic securities and rating agencies gave AAA ratings to those securities, they are not to blame; it’s the fault of the legislators who didn’t make those activities illegal and the regulators who didn’t enforce the rules that did exist.

But that is an unsatisfying, academic, and patronizing concept of blame.

Take the mortgage broker who steered his client into a subprime mortgage when the client could have qualified for a prime mortgage (because the subprime mortgage paid a higher commission), thereby saddling him with interest payments the broker knew he couldnt’ afford; or the bankers who sold small towns in Wisconsin synthetic CDOs without making sure the customers knew what they were buying (but covered themselves by shipping hundreds of pages of unreadable disclosures). From a pragmatic perspective, there’s nothing you can do about people like that; they exist, they will do whatever they can within the rules to make money, and the only answer is to tighten the rules.

But from a common sense, everyday perspective, of course they are to blame. They were making money for themselves by hurting other people, and they knew it. There’s nothing wrong with President Obama criticizing them. And if there’s a way to punish them – legally, and to an extent proportionate to their culpability – we should do it. If the only way to punish them is to drag them before Congressional committees and make them endure the spotlight, then that’s fine by me.

But, Posner says, “This hostility and air of menace make financial firms reluctant to get into or stay in bed with the government, and thus impede the bailout efforts.”

There are two answers to that claim. First, it assumes that we need the financial firms we have now, in the form they are in now, with the directors and officers they have now, and therefore we have to plead with them to let the government bail them out. This is an unnecessary assumption. Unfortunately, it is one that seems to be shared by the current administration.

Second, and more importantly, it amounts to coddling bullies. The implicit principle is that whenever a major institution does something wrong – but not illegal – we have to overlook it, because we are more dependent on that institution than it is on us. Actually, the principle would still apply even in the case of illegal behavior. Let’s say a large bank had done something illegal. They would still be too big to fail, we would still have to bail them out, Posner would still oppose a government takeover – “because of the manifest inability of the government to manage banks competently” – and so we would still have to make nice, for fear of scaring away the banks we depend on.

If I wanted to take the economistic approach, I could say something about moral hazard at this point. But I don’t want to take that path. The idea that people can commit egregious misdeeds at the expense of other people, yet cannot be criticized by our own government – the body that is supposed to represent our interests – violates a simple, common sense notion of justice. At least the one that I hold.

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About James Kwak 133 Articles

James Kwak is a former McKinsey consultant, a co-founder of Guidewire Software, and currently a student at the Yale Law School. He is a co-founder of The Baseline Scenario.

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