Capitalist Myopia

In 1955, the song, Sixteen Tons, written by Merle Travis and sung by Tennessee Ernie Ford, alluded to the down side of company stores. What seems surprising is the popularity of a song about owing one's "soul to the company store" among a  workforce that by 1955 had generally benefited from re-emerging post-war economic growth and heightened union activity. That the workforce had become more "white collar" and  that many employees were not actually members of unions makes it all the more puzzling. 

The company store has been a well-known and near-archetypal feature of Appalachian culture since well before my time. Coal companies built homes for their workers in areas where there was coal, but where there was often no other commercial activity. It was necessary to have a town if one was going to have workers nearby to extract the coal. The houses tended to look the same and were usually built close together. They were rented to workers with leases that enabled companies to quickly terminate and oust troublesome (i.e., union supporting) or unproductive workers.

It was also necessary to have a store where workers could purchase the necessaries of life, so companies often provided a store as well as housing. Sometimes rent payments and purchases were deducted directly from miners' paychecks. You would think the resulting reduction in transaction costs would result in lower prices, but you would be wrong. Rents and company store prices tended to be higher than prices in nearby competitive markets.

Another "innovation" was the use of company scrip instead of US currency to pay wages. Scrip was only good at the company store. This assured that mining companies recaptured through monopoly prices some of the wages they paid. It occasionally allowed them to raise wages without eroding their profits (since they could recover the wage rise through higher store prices and housing rents).

The growth of other sources of jobs and the growth and legal empowerment of unions gradually eroded mining company power. This link from the West Virginia Division of History and Culture provides credible evidence that concentrated mine company economic and political power led to abuses and to violence on both sides of the "dispute."

I think about company towns and company stores whenever someone starts bleating about government power; the sameness that would be induced by government control of the means of production; the two-tiered system that will evolve if government has too much power; the inefficiencies that will result from government regulation. All more or less true. But then I think of the sameness of company town housing, the two-tiered system of worker and management, and I think of the "inefficiencies" of unsafe workplaces and the "race to the bottom" that must necessarily ensue in the absence of a common standard for consumer and worker safety. And I conclude that economic and political power should not be concentrated excessively in anyone's hands, whether public or private, and that a government constituted to be of, by and for the people will almost certainly have to provide some countervailing force against excessive corporate economic and political power.

Finding the balance will always be the problem. Simple answers will almost never be right.

Company stores and company towns were a way for those with economic and political power to extract a few more dollars from the people doing a lot of the work and assuming a lot of the workplace risk. Like investment bankers who apparently couldn't come up with (as Joe Stiglitz put it in Freefall) a good mortgage product with"low transaction costs and low interest rates" that "would have helped people manage the risk of home ownership, including protection in the event their house loses value or borrowers lose their job," so some coal companies could not come up with a means of providing necessary housing and food to employees without also further impoverishing workers and enriching owners. That lack of creative, far-sighted innovation got them (and us) unions and excessive regulation. A communist plot? Hardly. More like capitalist myopia, something that seems to plague certain sectors of our capitalist economy in ways that doom them (and us) to repeat the past.

The socially detrimental effects of capitalist myopia continue today. Yesterday, I learned that Congressman Brad Miller (D-NC) has unearthed yet one more example of the ways in which self-interest unconstrained by ethics or regulation does not yield a socially optimal outcome (if "socially optimal" includes the welfare of people other than bankers):

So where does the conflict of interest lie? Often, the same bank that services a primary mortgage owned by another institution also owns a second mortgage or home equity line of credit on the same property. When that borrower has trouble meeting both payments, the servicer has an interest in making sure that amounts owed on the second lien, which it owns, continue to be paid even if the first loan, which it has no interest in, slides into delinquency. About two-thirds of primary mortgages are serviced by banks who do not own them but hold the accompanying seconds....

The top four banks hold approximately $450 billion in second liens that are supposed to take a backseat to the investors who hold the primary mortgages. But because of the front-seat role big banks play as servicers, they are in a position to put their interests first.

“Unless we can make servicers modify mortgages through bankruptcy or eminent domain, the servicers are not going to reduce principal,” Mr. Miller, 57, said in a recent interview. “Their stance does seem largely driven by accounting concerns — they are trying to maintain the fiction that the mortgages are worth the value they are carrying them at on their books.”

Enter Mr. Miller’s bill, the Mortgage Servicing Conflict of Interest Elimination Act. It bars servicers of first loans they do not own from holding any other mortgages on the same property.

Mr. Miller’s bill has not gained much attention since it was introduced in March. But it ought to, because the Dodd-Frank financial overhaul law is utterly silent on servicer conflicts.

But there's a higher cost to capitalist myopia than what we will (or won't) see on our national and bank balance sheets. Like mine company owners' and mine workers' objectives, bankers' objectives and borrowers' objectives have parted. At present, there appear to be few market or other forces that will reunite them.  I learned last week that borrowers are refusing to repay billions in home equity loans.

Even when a lender forces a borrower to settle through legal action, it can rarely extract more than 10 cents on the dollar. “People got 90 cents for free,” Mr. Combs said. “It rewards immorality, to some extent.”

Utah Loan Servicing is a debt collector that buys home equity loans from lenders. Clark Terry, the chief executive, says he does not pay more than $500 for a loan, regardless of how big it is.

“Anything over $15,000 to $20,000 is not collectible,” Mr. Terry said. “Americans seem to believe that anything they can get away with is O.K.”

But the borrowers argue that they are simply rebuilding their ravaged lives. Many also say that the banks were predatory, or at least indiscriminate, in making loans, and nevertheless were bailed out by the federal government. Finally, they point to their trump card: they say will declare bankruptcy if a settlement is not on favorable terms.

“I am not going to be a slave to the bank,” said Shawn Schlegel, a real estate agent who is in default on a $94,873 home equity loan. [Emphasis added.]

"People got 90 cents for free...it rewards immorality." What does that remind me of? Oh right, Goldman getting 100 cents on the AIG-owed dollar courtesy of the US taxpayer. Is it too much to hope that Mr. Combs also views Goldman's gains as a(n unfair) reward for ineptness at best, immorality at worst? And why accuse homeowners of immorality rather than ineptness? When I see a banker and a potential homeowner seated at a table about to conclude a real estate sale, I assume the burden of due diligence and ethics is on the person purporting to represent the expertise in this market. Where I come from, that expertise is what would justify someone earning a profit from the transaction. If, in fact, bankers were just betting on rising real estate prices without regard to the buyer's welfare, then they're just another card shark and they deserve to lose if the bad hand they dealt from their cuff comes back to bite them.

"Americans seem to believe that anything they can get away with is OK." Gosh, I wonder where they got that idea? Am I the only one who believes that ethics comprises the weft of our social fabric, but that it is not entirely derived from inner ethical policemen (or women) who reside within our breasts and cause us to behave virtuously, even as the very rich and politically powerful are publicly reaping the spoils of highly unethical behavior? For years now, our norms and beliefs have been shaped by rhetoric in support of unfettered self-interest. They are now being reshaped by highly public and immoral behavior that has so far gone unpunished. Not exactly a blueprint for the virtuous society, is it?

"I'm not going to be a slave to a bank." I will only note that it is very difficult to "sell" indentured servitude, especially servitude derived from self-chosen moral shackles, when the holder of the mortgage one owes has so very publicly evaded those very same bonds.

But there's more.

Marc McCain, a Phoenix lawyer, has been retained by about 300 new clients in the last year, many of whom were planning to walk away from properties they could afford but wanted to be rid of — strategic defaulters. On top of their unpaid mortgage obligations, they had home equity loans of $50,000 to $150,000.

Fewer than 5 percent of these clients said they would continue paying their home equity loan no matter what. Ten percent intend to negotiate a short sale on their house, where the holders of the primary mortgage and the home equity loan agree to accept less than what they are owed. In such deals primary mortgage holders get paid first.

The other 85 percent said they would default and worry about the debt only if and when they were forced to, Mr. McCain said.

“People want to have some green pastures in front of them,” said Mr. McCain, who recently negotiated a couple’s $75,000 home equity debt into a $3,500 settlement. “It’s come to the point where morality is no longer an issue.”

Darin Bolton, a software engineer, defaulted on the loans for his house in a Chicago suburb last year because “we felt we were just tossing our money into a hole.” This spring, he moved into a rental a few blocks away.

“I’m kind of banking on there being too many of us for the lenders to pursue,” he said. “There is strength in numbers.”

People do indeed want to have green pastures in front of them, not a company town, not a company store, not a wholly-owned company nation. They want an economic arrangement that leaves something extra for them and their children. It's an important component of the wealth of nations. In some ways, it doesn't really matter if a private bank siphons off large portions of your disposable income for decades to come or if the guvmint does it. Either way, you're poor and virtue is seldom a sufficient reward.

And, yes, there is strength in numbers, especially in a democracy (unless, of course, one can successfully distract the people with emotionally-laden issues like gay marriage, guns, race, abortion, undocumented workers).

"But wait!" you say, "Strength in numbers? This sounds suspiciously like the beginning of collective action. Egad, what's next? A union or a strike or, worse, class consciousness? Why we have only (gasp!) capitalists to blame for this!"

Ironic, is it not? Socialized investment banking, the result of unfettered self-interest in combination with unregulated conflicts of interest, may accomplish what generations of coal miners, steel and auto workers, teamsters, teachers unions, and union organizers could not. Unfortunately, collective action uninformed by virtue is unlikely to result in anything that is any better than that achieved by investment banking without virtue. It might even be worse.

That will be the true cost of capitalist myopia.

Comments

[MosesZD]

Two years ago I got a call from a bank. They were asking questions about a letter I'd written for a client confirming that he'd been self-employed for two years.

I re-read the letter and it, basically, said "he's human, he gave me two tax returns that indicated he was self-employed, and that he's hired me to do his taxes, but his records were not in order so I had to extend the return."

He was making $15,000/year as a "painting sub-contractor" for a big builder. I wouldn't have rented him any thing but the smallest apartment.

The bank financed a $250,000 house. Even though they'd taken his two prior returns and KNEW he was clearly not making any money.

So when I read about "immorality" I cannot be help to think about these banks and mortgage brokers getting fat on origination fees of loans given to people that could not, under any circumstance, be considered credit worthy for a purchase of this magnitude.

[Jeff V]

I've often wondered how overly-dominant companies are any different from overly-dominant government.

On the other hand, alot of folks in my hometown of Detroit made a good living with a secure retirement during the time-period when the Detroit automakers were overly dominant; foreign competition transformed, e.g., Flint, Michigan from "Wealthiest Middle Class in America" to "Giant Craphole."

On the other, other hand (yes, my third hand), The gains for the average worker were won in part by unionization. The UAW was a response to the oppressive "Dominant Company" culture in the auto industry. Henry Ford, e.g., kept close tabs on his employees outside of work to ensure they were living "Approved" lifestyles.

[ryan a]

"And I conclude that economic and political power should not be concentrated excessively in anyone's hands, whether public or private, and that a government constituted to be of, by and for the people will almost certainly have to provide some countervailing force against excessive corporate economic and political power."

Exactly!!! What I can't understand is why so many people think that it's either ONE SIDE or the other that is always the primary problem. For the devoted followers of Friedman, private enterprise is always about freedom and virtue--they have such a high regard for the private sector that their thinking gets completely ridiculous at certain points. Corporations are certainly not completely angelic, ethical entities--and there is plenty of room for power plays and corruption. The Friedmanites are just as blinded as the most devout marxist who blames everything under the sun on "capitalism". I always love folks who are so stuck on rigid dichotomies and absolutes.

Great post, as usual.

[Richard Knox]

I think there is an economic fact of life that you are not discussing. There are only 3 ways for the Private sector to de leverage: repudiate debt, have the government run a deficit, or have the foreign market run a surplus.

This is not a correlate of Keynsiansim but the consequence of the fact that for every sale there must be a purchase. If the private sector deleverages - and thus sells more than it buys - then one of the other two must buy more than its share. Taxes reduce the buying capacity of the private sector. The government must buy more than the taxes taken from the private sector in an amount sufficient to balance the private surplus. Or the foreign market must buy some of this surplus. Purchases must equal sales - by definition.

Thus debt repudiation is the alternative to shifting the debt burden from the private sector to the government. It causes pain to the lending class - who are of course the moneyed class - who are of course the group in power. Governments don’t like to see powerful people in pain.

[M Sakel]

Excellent, insightful post....

[Allen]

Mr. Knox,
You touched upon a very key point in your comment. I have been trying to get my mind around this. Those who say we should cut government spending don't seem to grasp this. If the government runs less of a deficit we have to import less and export more (not too likely) or private citizens and corporations have to go into more debt. Am I understanding this correctly? Please elaborate.

[Richard Knox]

Exactly - it has nothing to do with Keynes - merely that every sale must be accompnied by a purchase.

An individual can improve his balance sheet by reducing his spending to less than what he sells - typically his wages. He does not realize that when he does this, in order for the economy to pay his wages - someone else must do the opposite - buy more than he sells. In a closed system you can not run a surplus because every sale is balanced by a purchase. In a closed system if I buy less than I sell, someone else necessarily bought more than he sold, exactly in the amount of my surplus. I can improve my balance sheet by x only if someone else reduces his balance sheet by x.

Right now the private sector is running a surplus of 5pct gdp, the foreign trade balance is 5pct gdp against us and (duh) the govt is running a deficit of 10pct gdp. The sum of this total system must be zero - which it is.

Conservative dumbnicks point to the fact that when the govt runs a deficit the private ecponomy runs a surplus and erroneously conclude the private economy is saving to pay for future taxes. In fact it merely is that when this end of the teeter totter is up the other end is down. They could theoretically be right, but of course it might be that people are scared and not spending as much as they earn, and to keep them employed the government has them on the dole. That dole may or may not prime the pump - which is a different issue, but it may be better than a revolution. If the govt stopped its 10pct gdp dole the economy would drop by 10 pct and another 10 million or so would be out of work which would scare the beejezus out of the rest who would start to save more - death spiral.

If the private sector ran a surplus (sold more than it bought) than either the government must have bought more than the taxes it took from the private sector, or the foreign market must have bought from us more thqn they sold to us.

Excuse - a bit longwinded - easier to write too much than the right amount.

Cheers.

Martin Wolf did a nice column on this in mid June and another in mid July.

I'm babbling because it seems that this very simple idea is hidden in a pile of obfuscation when it should be the starting point of all public discourse on the subject of governments role in the economy.

And I love your essays - you are so on point and have such a nice way of explaining things.

[Richard Knox]

Pls escuse - above phrased poorly - 97% directed to Allen, last 3% directed to Ms. Udall. Once you submit I dont believe there is a way to edit.

[Allen]

Thank you for clarifying. A point that confuses me is which way to count the trade balance. If I call the 3 parts of the equation:
private sector, individual and corporate = P
Foreign trade= F
Government=G

P+F+G=0

But how do I determine the sign on F? + because foreigners are buying more than they are selling? I can see that if P is saving more than spending, then G must be spending more than saving but fitting F in confuses me.

Actually, just as I was typing I think I got it clear. P is saving so they are taking money out of the domestic economy. F is removing money also since we buy more from overseas than we sell. So G has to put back in an equal amount. There, does that make sense? You don't really understand something until you can explain it someone once told me. Where are Mr. Wolf's articles available?

[Richard Knox]

Allen - While you’ve got it right, I suggest you not think in terms of putting money into the domestic economy because you can then get this subject confused with the subject of creating money. Think instead in term of buying and selling.

P is a net seller, F is a net seller, thus Gvt is a net buyer.

Note - foreign trade accounts are carried with the opposite sign as you might expect.

For any market the sales are equal to the purchases. Example - in Dogpatch the sales of vegetables equals the purchases of vegetables. You and I grow vegetbles. I grow carrots, you grow onions. We meet each day at the market and I buy $1 of onions from you and you buy $1 of carrots from me. The gross product in the Dogpatch vegetble market is $2 per day.

You decide to save money and only buy $0.50 of carrots per day.

(1) I continue to buy $1 of onions. The gross product has dropped to $1.50 per day, and further I am using up my savings or borrowing somewhere - but that is a different subject. Regardless of how I finance it, the total sales are equal to the total purchases. Note that the only way you can maintain your sales is bercause I am reducing my net worth. Your thrift is causing my unthrift. NOte also that I had to reduce my production which is why gross product declined.

Maybe an outsider comes along and buys the 0.50 of carrots and does not sell us anything. We are in balance at $2 and your thrift is balanced by the outsiders unthrift.

(2) I decide to cut my purchases also, and buy $0.50 of onions per day. Now gross product is $1 per day. But note that your sales have dropped so that you are no longer running a surplus.

A part of market can run a surplus but the total market must be in balance.

Now switch to a different market - the US market for new things and services - GDP. Same holds.

Martin Wolf writes a column at the Financial Times - they have a web site

here is the june 15 essay

http://www.ft.com/cms/s/0/fc8d1dd4-78b6-11df-a312-00144feabdc0,s01=1.html

[Rental]

Happy New Year! The author write more I liked it.

[Hotjobs]

Happy New Year! Happiness and success in 2011.