Opinion: The US corrupted

  By Neville Bennett When Leslie Young, the expatriate Kiwi, speaks of the US which he knows so well, he sees institutional weakness and the corruption of the dominant Washington and Wall Street elites. His analysis rests upon profound reflection and originality, quite unlike any other analysis that I have seen. Few could write the analysis: a participant needs brilliant maths and elite's membership. Professor Young is there because of his D.Phil. Oxon with expertise in maths, finance and economics and a chair at the University of Texas. And he is forthright: even now Wall Street is good at making money, perhaps at the cost of wrecking an economy. Politicians are good at marketing themselves. The derivative rort The heart of the crisis lay in complex derivatives designed by brilliant young people typically from the University of Chicago. The derivatives were incredibly complex. This is a crucial point. Most mathematicians, much less bankers, finance experts and regulators could not comprehend them. If questions were raised, the experts had the advantage of high intelligence and were able to blind questioners with unrelenting calculus. The experts validated the cubed and squared sub-prime packages and insisted that history also validated them. This was contrived by fixing assumptions. For example, the ratio of failure in sub-prime repayment was taken from early issues, not later issues which turned to custard when house prices collapsed. With a low default rate, the products got high credit ratings. These derivatives ended as "the mask for expropriation" and "a shield against liability" by those who designed and managed them. Western Culture Math is fundamental to modern western culture. Professor Young writes "theorem" and then looks meaningfully at his audience and writes "theology" before resuming. (I mentally added "theory"). Young argues that this crisis is a logical outcome of a society which prizes abstract rules and complex structures. This has encouraged corporations and trusts to mobilize capital and create complex divisions of labour to pursue profit. The people with large IQ's and the right training can compound complexity in order to get an advantage. Unfortunately at the cutting edge, a whole group did that with derivatives, and siphoned capital out of the system. The system has already showed its weakness in the case of Enron. Moreover, the failure of Arthur Anderson to carry out a correct audit also reveals, Professor Young believes, a systemic sickness in US business. Andersons betrayed professional standards. Moreover, regulators failed to curb the excesses of derivatives or to devise reasonable credit-ratings. One could say charitably that they were paid less than the financiers, and outgunned intellectually. At this stage I asked why academics had been silent during this massive robbery. Prof. Young blamed the academic promotion system. Academic must publish in A+ journals, but A+ journals were not adapted to the simple idea that financiers were ripping off the public by peddling rubbish. In any case, most people in this sphere in universities were not really interested in the real world, preferring experimental economics and the higher flights of theory.  Professor Young believes that academics are lax in their role of "conscience and critic of society". He believes they should use the op-ed pages to reach the public. He has published twice in the WSJ this year. He believes it is obvious markets are not working but capitalist theology clings to the efficient market hypothesis. Western systems Professor Young clearly admires the best of the western system. He is impressed that the business environment has generally been separated from politics, and thrives on the use of rules such as the sanctity of property, which has never existed in China. It has systems to organize trade, employ labour, and accumulated capital. Millions of people deal with each other via the simple interface of the invisible hand of the market. There has been a tradition of integrity because professionals kept to the rules. A stranger could do business with a high degree of confidence that agreements would be enforced and relevant information would appear in accounts. Has this now changed? Perhaps not. But is the area of high finance, integrity is not so apparent. The problem may be rooted in the explosive growth of electronic information. It provides a tremendous comparative advantage to those with the intellect and ability to interpret masses of information. Asymmetry In high finance there is a knowledge gap between managers and shareholders. Managers have been able to design complex gambles which they profit from upside in bonuses and fees but shareholders carry the downside. Managers have effectively expropriated the capital and brand equity of their firms. The originators of the derivatives siphoned off money  leaving shareholders with toxic assets. The financial system has become extremely fragile because it was highly leveraged. Free markets are supposed to allocate capital efficiently, but the financial system has distorted that massively. That system is close to collapse. Government has had to intervene and its bail-outs now threaten its credit- rating. Its fiscal problems had been increased by financial manipulation, like the transfer pricing practices of multinationals which shift profits offshore. Other US structural weakness Professor Young believes the US's rule-based democratic governance has exacerbated the crisis in some respects. In contrast to China which has spent its stimulus quickly the US's stimulus has been delayed by rules designed to ensure fiscal integrity. It was packed with "pork barrel " elements: these are irresponsible expenditures added by congressmen to curry favour in their constituency. Such expenditures by the Washington elite increase the deficit without adding macroeconomic benefits. This elite also likes its toys; the continued massive spending on new weapon systems that have no obvious purpose. The US needs a more effective health system and financial regulation , but new legislation will be made ineffective by the influence of lobbies. Yet the states are suffering, especially because of the requirement that they have to balance their budgets each fiscal year. As receipts have fallen they have exacerbated the recession by cutting expenditure. The US has pumped trillions into the banks but credit has not increased appreciably. This crisis is mercilessly exposing the US's deep-seated deficiencies. ____________ * Neville Bennett was a long-time Senior Lecturer in History at the University of Canterbury, where he taught since 1971. His focus is economic history and markets.