Why We Consent to Market Intervention
The change, it had to come
We know it all along
We were liberated from the fold, that’s all
--The Who
Support behind the government’s bank bailout package or recent efforts to prop up firms like Fannie Mae (FNM), Freddie Mac (FRE) and American International Group (AIG) leaves some free market proponents scratching their heads. In a country founded on principles of individual freedom and liberty, how can majority support be marshaled for programs that interfere with market mechanisms?
Research by Staw, Sandelands, and Dutton (1981) helps explain why we yield to interventionist measures during times of threat. Their ‘threat-rigidity’ theory considers the problem of maladaptive response to environmental change. Synthesizing multi-level findings from previous studies, the researchers posited that people predictably respond to threatening situations in a ‘rigid’ manner and that these rigidities are expressed in two groups of behavior.
First, threat may result in a restriction of information processing, such as a narrowing of fields of attention, simplified information codes and language, or a reduction in information channels. Such behavior is rigid because it restricts search to a narrow set of possible responses to the threat. This helps explain, for instance, collective focus on the current bailout choice rather than seeking other well-reasoned alternatives such as the designs discussed by Mr. Practical or John Hussman last week.
Second, threat encourages consolidation of power and influence and decision-making authority that is concentrated at high levels of a hierarchy. Rigidities result from granting unilateral authority to a small coalition for determining appropriate response to the threat. Through this lens, we can readily explain collective willingness to replace democratic principles with a reliance on the judgment of a Treasury secretary or Federal Reserve chairman to speedily navigate the country through an intractable situation.
Rigid behaviors encourage less varied, inflexible responses to threats. When threats emanate from environmental change that is similar to past episodes, then these rigidities may be fully functional, since they encourage efficiency in enacting learned patterns of cause-and-effect responses that may have been effective in the past.
However, when the threat emanates from major environmental change, then rigidities promote dysfunctional pathologies of maladaptive behavior. When the environment has changed radically, flexibility and diversity of response have survival value (Staw et al., 1981: 502). Conversely, restriction of information processing and centralization of decision-making authority decrease the likelihood that novel solutions will be developed to cope with unique threats.
What to conclude from threat-rigidity theory in light of our present situation? If the current credit crunch is merely a different flavor of past crises, then our rigid behavior improves chances of effective threat resolution. However, if the present situation emanates from a historically unique confluence of factors, then probabilities of deriving effective coping mechanisms from our rigidities are reduced.
The longer-term implications concerning the sustainability of a society grounded in individual freedom and liberty are also interesting to ponder in the context of this theory.
References
Staw, B.M., Sandelands, L.E., & Dutton, J.E. 1981. Threat-rigidity effects in organizational behavior: A multi-level analysis. Administrative Science Quarterly, 26: 501-524.
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Only after this inventory is taken, classified and detailed and then released for public scrutiny, with disclosure of which financial institution it belongs to (or is holdingthe non-performing or defaulted paper) showing the amount of housing units in default, how much $$, and a grand total $$, should we even consider a bailout.
The proposed bailout is blind. This just isn't the way it is done.
All that aside, all defaulted mortgages should be accelarated to immediate foreclosure. This will put the debtor back in the rental market, allow investors to purchase the foreclosed property at market and quickly place the property for rent to those in need of housing (the foreclosed previous homeowner). This is a hard bite into the bullet, but it will cost far less than a bailout. It will be a shuffle of the cards in the housing market and it will bolster the cash flowing into the mortgage markets, providing the foundation for growth once again.
Bailout is not required, let the chips fall where they may, no free rides for anyone. Those institutions that acted prudently will rise to the top and replace those that played a game of financial Russian roulette. Failure is the reward of bad or poor business in a free economy, let us not go against common sense here.
LIBOR is widing, and T-bills are getting bought - again. I do find it difficult to see how the bailout - be it the Paulson Plan or the Congressional rigidity version - assuages the bank intermarket and it's counter-party fears; which is to say, it won't work.
