Advocates for the regulatory state are fond of complaining that things like the financial meltdown, the BP oil spill, and the like, are the result of an “unregulated marketplace.”
But it was federal loan guarantees that first made securitized mortgages into a marketable asset. And I wouldn’t consider a $75 million cap on liability to be exactly “laissez-faire.”
That’s right. No matter how bad an oil spill, no matter how many billions of dollars of economic damage it causes, the company is only liable for $75 million over and above cleanup costs. And they can probably save more than that on the bottom line by deliberately skimping on safety precautions, with a perverse incentive structure of (as Steve Horwitz puts it) “Heads I win, tails I don’t lose.” That’s exactly the kind of incentive structure that caused Ludwig von Mises to dismiss the Oskar Lange model of market socialism as simply “playing at the market,” because the manager had nothing to lose personally.
And libertarian class analysis tells us that, despite what idealistic liberals want to believe, creating such incentive structures is the main thing governments are about. As left-wingers like Noam Chomksky put it, the idea is to socialize risk and cost and privatize profit. And Murray Rothbard described it as “our corporate state” subsidizing the operating costs of big business.
Let’s take a look, instead, at how a free market (a genuine free market, in which all economic actors do business on their own nickel, as opposed to the system of corporate-government collusion we’ve had for over 150 years) might deal with something like the British Petroleum oil spill.
Without a government-imposed liability cap, BP would be liable to the full value of its assets not only for cleanup costs, but for the full amount of economic damages resulting from the Deepwater Horizon disaster. Estimates of damage to tourism and fishing center on around $5 billion, but it could be far worse if the slick spreads far enough to affect fishing and boating for Florida’s $65 billion tourism industry (just think of the Everglades). Keep in mind, also, that we’re not just talking about one-off costs this year; we’re talking about big hits to fishing and tourism for years to come, especially as the movement of toxic chemicals up the food chain may make Gulf seafood inedible for generations. This is not just a one-year loss of income from 130,000 fishing jobs, but possibly an end to these people’s careers. There are also possible indirect effects if the loss of wetlands increases coastal areas’ vulnerability to hurricanes.
And that’s not even taking into account the possibility of criminal negligence by BP executives — who apparently rivaled Massey Energy’s Don Blankenship in cutting corners for just about every conceivable kind of safety measure — and the cleaning out of their personal assets by angry juries.
And remember, we’re talking about liability in addition to cleanup costs, which were $3.8 billion for the less severe Exxon Valdez spill.
These cumulative damages stack up pretty tall against BP’s total equity, which was around a hundred billion (at least before its stock took a hit the last month or so).
So absent a liability cap, as the flood of individual and class action lawsuits ate up the company’s equity, the market pressure for holding robust liability insurance (for damages up to tens of billions of dollars) would be a well-nigh non-negotiable prerequisite for economic viability in the industry.
And let’s face it. After what happened with BP, in a legal regime with no limits to liability short of total liquidation of a corporation’s assets, insurers will have a pretty significant interest in making sure policy-holders don’t bankrupt them.
What passed for federal regulations were ineffectual because, among other things, it’s not the federal government’s own money that’s at risk. Things get downright chummy between regulators and regulated. Inspectors sleeping with executives and snorting crystal meth off of toaster ovens is what you call a “public-private partnership,” I guess.
I mean, seriously. When Congress and the White House are packed with people who all got millions of dollars in campaign contributions from all sorts of regulated industries, and most of the political appointees in regulatory bodies are former directors and vice presidents of corporations in the regulated industries, how tough do you think that regulation’s gonna be? Last I heard, brown pelicans don’t contribute much to campaign funds.
But if relations between regulators and regulated aren’t really all that adversarial, you know what is adversarial? Relations between insurers and the insured. Insurance companies are notorious for not liking to pay claims, and for taking an adversarial view of policyholders who make them. Especially when slipshod safety measures mean a multi-billion dollar payout from the insurance company’s own funds. And the “adversarial” relationship is likely to entail things like actual inspections to make sure the failsafe devices work, maybe requiring relief wells as a standard precaution, things like that.
Insurance companies take the kind of adversarial attitude toward the insured that liberals only wish government regulators took toward regulated industries.
Don't want to get into a political debate but from an economic perspective this analysis is flawed b/c absent a liability cap, BP (and all other petroleum co's) would have priced in the costs of potential negative externalities into the sale price; i.e., w/o a cap, price at pump for everyone would have been higher and BP would have had more cash to cover liabilities.
I wonder if there’s an oversight in your suggestion that in a truly free market this sort of thing wouldn’t happen – it seems to imply that the current regulation system and legal structure (and their accompanying loopholes) are a result of the political structure, when in fact it’s quite the opposite. The political system, and the laws and regulations are an expression of the underlying relations of production – that BP gets off easy in this event isn’t because it has bought some political favor, but rather the dominant financial status of BP (or rather, the relations of production which produce corporations like BP) ensures a political system which will allow it to buy political favor.
The acid-test to this is as follows: can you really conceive of a free market system in which BP would not use its substantial assets to ensure favorable treatment by a government? They haven’t co-opted some system built to ensure that corporations stayed responsible! Why would BP be any less likely to buy judges, lawyers, or politicians to make sure they continued to reap profits in a non-regulated market than in a regulated one? If you perceive that there is a perverse system of incentives put in place, don’t you wonder why those incentives are reversed in the first place? It seems unlikely that it was an oversight existing in the law which oil companies happened to (lucratively) stumble across.
I suppose what I’m really asking you is whether or not your solution is 1.) predicated on the idea of a system immune to financial influence, in which insurance companies or oil companies couldn’t buy judges, politicians, favors, etc. 2.) to what extent this is not only a fantasy but directly contradicts all empirical evidence?
Well TylerDurden, if that is your real name (and how weird would it be if it was?) there’s a simple answer to your “acid test”. What if there was no government? After all the website is the “Center for a Stateless Society”. Without a monopoly of force there is no way BP could buy the legal treatment it wanted, since anyone who tried to deliver de facto immunity from damages claims* would be ignored as a court. Only the fact that a limited number of people who have no financial interest either way makes the shielding of BP remotely plausible. Sure BP could try to buy influence in a free market, but why would it be more successful than the millions of people with damages claims against it? Remember they have as much to lose by the claims not being paid as BP has to gain by not paying them, by definition.
* A $75M cap is de facto immunity, there’s no way that
celocelo1, it seems to me as if your analysis presupposes that the expressed demand for petroleum products wouldn’t be affected by the higher price at the pump. This seems most implausible.
Tyler: It strikes me that you’re taking the “underlying relations of production” as a constant, whereas I take the basic structure of our corporate economy (large oligopoly corporations controlling production for large market areas, mass production methods using expensive product-specific machinery, etc.) as largely a result of a particular path the state sent us down. The corporate economy of the Gilded Age didn’t just emerge autonomously and then hijack the state–it was created by the state.
Celocelo: As Gary says, demand for fuel is probably a lot more price-elastic than you’re suggesting. In 2008 we were very close to seeing the long-haul trucking and airline industries just shut down 20% of capacity. And even with the collapse of prices since then, we’ve seen close to a 10% decline in gasoline consumption. With oil companies’ liability premiums internalized in price at the pump, I think we’d see a *lot* of strip malls be boarded up, and some radical shortening of corporate supply chains.
Kevin, I believe you very subtly touched on this point but I wanted to suggest something entering in from a different angle that makes it more explicit…
This little academic exercise is all fine and good and it does show, at least economically speaking, how a stateless situation would rectify this situation. However, I would go even further and devise a conjecture that would render this problem seemingly impossible from the get-go. More succinctly, probabilistically speaking how likely is it that a company such as BP would even exist in its current incarnation in an agorist society? The higher granularity of feedback of a market driven system would “shake out” any potential inefficiencies and bad business practices of any firm before they could manifest.
Sure, it’s not P = 0 but I believe it’s low enough to be driven as argument.
In a stateless society, it is economically rational to gamble more than you can afford to pay if you lose, if the potential payout is sufficient … and “sufficient” has no relationship to the potential losses of your victims.
Hypothetical: you have zero net assets (real assets vs. debt) PLUS the opportunity to do X (what “X” may be doesn’t matter; it could be flipping a coin or it could be drilling a well) which has a 50% chance of yielding you $1 Gazillion dollars, and a 50% chance of inflicting $2 Gazzillion of damage on your neighbors for which you would be liable. Do you take the chance?
Of course you do. If you lose the bet, you lose nothing because you can’t pay off. The company folds, the executives go elsewhere. But if you win ah! you are fantastically wealthy.
It does no good to about how executives would never do that because it’d look bad on their resume. Ask Carly Fiorina if her public career died when she ran HP into the ground.
The libertarian or stateless analysis (I’m sure there’s a difference) has plenty of value but is far from dispositive in matters of this sort. Certainly the $75 million liability cap is an error, but it might be worth analyzing how it came to be. It was the opposite of a nanny-state exercise.
@Gary: I just found a link here so I don’t understand half of what’s being said on this board, but economics of this spill are straightforward. Change in demand depends on price elasticity, and a few years ago we saw that a world with $130+/barrel of oil is plausible; demand is less elastic than we might suspect, mainly because society’s appetite for consumption is difficult to reduce, and because we don’t have good, cheaper alternative fuel sources yet. Continued emergence of developing countries like China will only continue to increase demand.
In the US, the $75mm cap is essentially a mechanism that shifted the cost burden of potential negative externalities (over $75mm) from the consumers of oil (vis-a-vis the oil companies) to…it kind of depends. A couple of the commenters began to touch on this concept: the cap essentially served as a form of option value that allowed our broader society to capture the benefit of lower gas prices, unless and until a big accident occurred (which it unfortunately did), by spreading risk.
The cost burden of the BP spill is currently being borne specifically by those on the Gulf Coast who are losing business (e.g., fishing companies, others, etc.), as well as the actual wildlife who may be paying with their lives. If the US gov’t compensates these bearers of costs, the cost burden will have shifted to the broader US taxpayers. If BP is forced to pay, then they (and all other oil companies) will eventually increase prices to reflect higher liability costs, and the cost burden will have shifted to consumers of oil. Since we all essentially consume oil in one way or another, the cost burden basically falls onto all of us in either case.
The BP spill highlights a straightforward notion that the price of oil to society hasn’t been as high as it should have been. There are two ways* to reduce these costs to society: 1) reduce our consumption (which is difficult but needs to be promoted anyway); and 2) create alternative sources of fuel with lower cost burdens (cheaper, cleaner, safer, etc.) that increases overall supply of fuel.
*There is an option 3): create more supply by drilling for more oil. Of course, this is what Repubs and Dems are fighting about. Right answer depends on whether or not each additional barrel of oil creates net marginal benefit (productive value vs. production costs, environmental costs, potential neg. externalities, opportunity costs., etc.). Difficult to measure.
Kevin, good post. I imagine that the $75 million liability cap affected decion-making by BP managers in any number of ways, but let me note that the cap doesn't apply (1) to claims by state and local governments and (2) if BP is determined to have been grossly negligent (since this cannot be determined in advance of final judical decision, a potentially much larger sword was hanging over BP's head, even if it was discounted to zero by BP). Still, I agree with you about oversight by insurers, but one wonders whether BP actually insured any of its risk here. They certainly have been more likely to do so if there was no liability cap whatsoever.
You fail to note some other, more basic government interventions, partiicularly the grant of zero liability to shareholders, which both (i) incentivizes shareolders to look the other way at corporate activies that profitably shift risks to third parties and (ii) generates agency problems which leave shareholders vulnerable to poor decision-making by executives.
Finally, you and celocelo1 miss another way for society to force oil cos like BP to internalize more of their costs – expand and formalize "catch rights" programs that empower fishermen and other resource users (including when and where oil/gas is developed), and direct rights to use polluters, and end the current system, where they are both trapped in a tragedy of the commons and beholden to government for protection of the resources and in he case of damages suffered. I discuss catch rights over at my blog.
Regards,
Tom
"But it was federal loan guarantees that first made securitized mortgages into a marketable asset."
Huh? Derivative markets have been around long before FNMA. Bundling toxic goods and marketing them to unsuspecting investors has absolutely nothing essential to do with the federal government. The fed may generate more toxic products, but the free market itself is the source for derivative trading in which companies can bet against their own success.
You dudes shouldn't be taken seriously until you stop toeing the Republican line on the cause of the financial crisis. Upgrade please.
"Toeing the Republican line?" When you say the "free market" is the source of the global corporate economy and the bloated FIRE economy we have now, and equating corporate domination to the "free market," YOU are the one who sounds like a Republican.
The government has, in fact, done a lot to make mortgage-based securities more marketable and less risky as an investment:
http://c4ss.org/content/2406
If the Republicans agree with part of what I say about the role of the feds in creating a large-scale market for MBS, so much the better for those bastards. I doubt you'll find many Republicans who agree with what I said in the second part of that linked piece.
Tom: Re negligence voiding the $75 million cap, I hope that BP being cleaned out and driven into the ground by class action suits will create a demonstration effect for the other oil companies. As somebody said, take a shitty little oil company and throw it against the wall. Seeing a $100 billion company torn to pieces by plaintiff might make be a "come to Jesus" moment for the rest of them when it comes to safety measures and liability insurance.
Re shareholder liability, I'm quite ambivalent on that. I've followed your arguments re the corporate veil as a "plausible deniability" device and found them to have some merit, but in the end it makes more sense just to treat "shareholder ownership" as a myth. Shareholders are IMO better treated as just another kind of contractual claimant, analogous to bondholders, with the real owners being the management. The most "effective" mechanism for shareholder control, selling one's shares, is about as effective as controlling GM's policy by reselling one's car on the used vehicle market. The hostile takeover was essentially emasculated after a brief period of adaptation in the 1980s, and proxy fights are about as viable as a Green Party candidacy. So despite all the Michael Jensen crap about "entrepreneurial corporations," the corporation today is just as managerial as ever. It's just that instead of being a faceless bureaucrat, the typical CEO has been corrupted by the unintended consequences of Jensen's agency/incentive reforms to game the system to max out his own bonuses and stock options.
Kevin, I don’t think a “free market” is coherent. Belief systems and institutional norms set the parameters for markets. Even in a society that never deviated from NAP, people’s interactions would be constricted by internalized factors. Preferences can always be manipulated — whether in a NAP-ruled world or not.
(I should note that I do understand what you’re saying 99% of the time. I do demarcate “corporate rule” from “free markets” when I read your writing — which I find compelling 99% of the time. I just think there’s an odd bug when it comes to the recent financial crisis. Government cannot act without cooperation from hedge funds and insurance agencies that back-up those actions. The root is two-pronged at all times — even in the housing bubble. You usually note that. I’m just pointing to the absence here.)
“The government has, in fact, done a lot to make mortgage-based securities more marketable and less risky as an investment…”
I agree. But the point though is that without hedge funds and insurance agencies, the government policies could not have created systemic failure.
I agree with a good number of the points made in this.
However, insurance is nothing but a legalized ponzy scheme in the first place. I grew up before liability insurance was required by law to drive a car and I can tell you that people were much more cautious driving back then because that fender bender one caused by following too closely to another was going to be paid for out of their own pocket.
Which would further reinforce the points made in regards to having to pay full amount of damages for things like BP's Horizon debacle. Don't you think that BP's exec's would have even thought about ignoring safety issues if the cost for doing so was going to come directly from BP and possibly, as it should be, from their own pockets?