Wednesday, October 15, 2008

"War [Crisis] is the Health of the State"

Yesterday, the Treasury announced that it will embark on an historically unprecedented semi-nationalization of a major industry. With the continuing evolution of the “bail out” package, the Treasury will now force nine major financial institutions to sell $250 billion in preferred stock to the government.

I don’t wish to discuss here the economic argument for and against this or whether it will help us in our current situation. Personally, I think there is some merit in this in the short run for stabilizing the economy, but I want to address the broader picture.

What really bothers me is the long term implications of this action with regards to the role of government, the preservation of freedom, and the very system that this country was founded upon. It was famously said by Randolph Bourne, that “War is the health of the state.” I think in general "crisis" is more accurately the health of the state, because in our panic we tolerate the enhancement of unprecedented government power. The problem is, that almost always these extended powers never get removed after the crisis ends. There are a number of areas with this recent action where I have some concerns and questions.

1. What does this mean for property rights? Even though some of these institutions are more then willing to participate in this deal, others are having this forced upon them. By issuing more shares to the government, even if they are being bought, this necessarily dilutes the stake of existing share holders, reducing the percent of the company that they own. In effect, they are having a portion of their property forcibly taken from them. Paulson allegedly told the officers of these nine firms that “they needed to participate in the program for the good of the national economy.” Having this rationale in the wake of the recent Kelo decision, where the Supreme Court ruled that a local government can seize property for the sole purpose of “economic development,” begs the question is there anything fundamentally sovereign about property rights anymore? Do we as individuals only have rights to property in so far as government does not see a better use for it? This completely falls in the face of the principles of no unreasonable search or seizure of the 4th Amendment, where with the exception of eminent domain and punishment for crime, property is protected. Will this set the precedent that government can take your personal property for any reason it sees fit?

2. This only expands the corrupt and disastrous merging of corporate and government power into a Corporatist system. Much of our problem with Fannie Mae and Freddie Mac was its hybrid public/private nature. The government backed private risk taking. These private firms were some of the largest campaign donors to the very people who are charged to oversee them (including our fellow PC alum Chris Dodd, chairman of the Senate Banking and Finance Committee). There were accounting scandals in 2004 that would have been punished by courts in the private sector but largely overlooked because of political influence. Essentially now, the Federal Government has a huge conflict of interest in partially owning a private industry, while at the same time the private industry will be able to wield tremendous power in the halls of government.

3. What happened to personal responsibility? Despite having many incentives to engage in risky lending in recent years, some banks such as Wells Fargo largely avoided this. Now they are being punished for their prudent action. What is the incentive for participants to act responsibly moving forward? What is the disincentive to not act recklessly in the future?

4. This is a major increase in the power of the state and the executive in particular. The “bail out” bill essentially gave a 700 billion dollar blank check to the Treasury Secretary to use as he sees fit. And the purpose of this seems to be changing by the day. First it was to purchase bad mortgage securities via a reverse auction from willing institutions. Then it was extended to include all forms of debt. Then, as the Democrats in Congress wanted, the Treasury COULD buy equity stakes if the firms voluntarily agreed to it. Now the government is forcibly buying equity stakes in these firms. What will it be tomorrow? The forced nationalization of the entire industry? Furthermore, there is no requirement regarding when the government must sell these shares in the future. They could simply keep them indefinitely.

I feel like I need to read my copy of Hayek’s The Road to Serfdom again. I suggest those who have never read it get a copy.



While I agree with your concerns, EJB, I believe I'm less worried about this Congressional act than you might be. Thus while I concur with your basic argument, I must write separately to point out a few things.

First, the comparison to Kelo. Now, as those of you who know me know, I am a strong supporter of private property rights and a staunch opponent of eminent domain (to the point where I would suggest abolishing it in all cases). I've even been thrown out of my Constitutional Law class for telling Supreme Court Justice Stephen Breyer that his decision to join the majority in Kelo makes him partially responsible for the fourth worst Supreme Court case in history (closely behind Plessy v. Ferguson, Korematsu v. US, and Buck v. Bell). I also recognize that you are NOT equating the two are NOT arguing that the bailout is just like Kelo.

However, you do make the argument that: "By issuing more shares to the government, even if they are being bought, this necessarily dilutes the stake of existing share holders, reducing the percent of the company that they own. In effect, they are having a portion of their property forcibly taken from them." This is not exactly the case. Nothing is actually being taken from shareholders, because the preferred stock that is being sold to the Treasury is being created for this specific purpose. Yes it dilutes the value of the stake of the shareholders, but that's all it does. For eminent domain purposes, it would be similar to the government putting a prison right next to your would certainly decrease the value of your property, but it would not constitute a taking. Unless your argument is that the AMOUNT of stock is not the property, but the VALUE of the stock is - however, nothing like this has ever been upheld by the Supreme Court and, in fact, Palazzolo seems to expressly close that avenue of argument.

Similarly, you make the point that the government paid for these shares. This is crucial in any examination of a Takings Clause violation, because takings are allowed if the property owner is "justly compensated." This is why I hate our current Takings Clause analysis. What is "just compensation?" Does it include idiosyncratic value or subjective valuation? (No.)

It's also interesting that you mention the Fourth Amendment. Nowhere in that Amendment is there mentioned an explicit right to private property. But I agree with you that Eminent Domain and other unjustified takings violate the spirit of the Amendment! Does this mean you recognize an implicit fundamental right to both private property and privacy!? I can't believe this is the same EJB that I knew in college!

I completely agree with #2 and #3.

Finally, a few comments on #4. First, "a 700 billion dollar blank check," is logically impossible, because a blank check, by definition, includes no written value. But that's technical. To your point about the drastic increase in executive power, I will say that I'm not as alarmed about that as one might be if this were the executive acting AGAINST the express will of Congress. In Youngstown, the inherent power of the President was examined because Truman tried to take over the steel industry when its workers went on a mass strike during the Korean War. Justice Jackson's concurring opinion is, to this day, the lodestar for such analysis. Basically, the Executive's power is at its strongest when he acts according to the express or implied authority of Congress. His power is at its weakest when he acts contrary to their express or implied will. And there is a middle zone that gets murky when we're not sure what Congress has said on the issue. In this case (the banking crisis), I feel slightly more comfortable with this increase in executive power because it was expressly authorized by Congress. These two forces are naturally opposed to one another, so the fact that they are working in tandem should probably evidence the fact that the increase in power is necessary to quell a pressing problem. Perhaps your "parade of horribles" argument is right and this is the first step towards the nationalization of industry. But with Youngstown firmly in place, I trust it will never come to that point.