Eliot Spitzer examines the role of government in markets in a clear and compelling manner. He calls for government intervention in three ways: enforcing market integrity; correcting externalities; and defending core values.

I agree that all three tasks are important, but we have to ask what it takes to have government implement them in the broad interests of society. Both left and right support enforcing market integrity over protecting specific individuals or institutions, but bringing that about in a money-drenched political system is challenging. As Mancur Olson famously pointed out in The Logic of Collective Action, promoting public over special interests can be massively difficult.

While an undergraduate at MIT, I learned that market economies were a means to meet social goals and that finance should serve the economy. In recent years the servant’s servant became the master’s master. From James Carville’s 1993 comment about wanting to be reincarnated as the bond market, to the Committee to Save the World in the late 1990s (it didn’t, it just set us up for a bigger bubble later), to the dawn of the present crisis, goals were defined through a lens that turned what was good for investment banks into what was good for America. An awful lot of ideological manufacture went into this inversion between means (markets) and ends (social goals). It contorted the structure of society, and, for many, made paying homage to the market a core value.

Beginning with Ronald Reagan, we have had more than 30 years of denigration of the role of government. Yet the god called “the market” showed that it could not be left unattended. As foreclosures of homes skyrocketed and unemployment rose to the verge of Depression levels in some areas, we found out that the wild activities over in that corner called Wall Street could spill over (externalities) and destroy the lives of hard-working people powerless to escape the damage. Faith in unfettered free markets has been shattered.

Yet the end of faith in markets has not, as in the 1930s, been replaced by faith in the public sector. The present challenge is made more difficult by the bailouts under both Bush and Obama, which unmasked Wall Street’s power and influence in government and produced outcomes most Americans considered offensive and unjust. Our government lost legitimacy before our eyes. The dreadful bailouts reinforced the Reagan mantra that “government is not the solution to our problem; government is the problem.”

Not only have we lost faith in markets and government, but expertise is now widely suspect as well. Who can be a trusted expert? After all, most noteworthy financiers, corporate leaders, economists, and finance professors went along with bubble finance without registering any concern. All the mathematical and statistical models that economists and financial specialists developed don’t matter for much if they could not predict the crisis, explain it ex post, or provide useful remedies. Many social scientists and financial regulators were enablers or, at best, hid while Wall Street spun out of control.

Without trust in markets, government, or experts, what is the path forward?

We must first accept that drawing simple distinctions between markets and government as means to social ends may not be realistic. Economics Nobel laureate George Stigler’s 1971 critique of government and regulatory policy as susceptible to capture is even more germane in the era of wide-open corporate campaign finance, turbocharged by the recent Supreme Court decision in Citizens United vs. Federal Election Commission. The decision will make it even more difficult to keep government focused on market integrity and correcting externalities. The too-big-to-fail banks have spent upwards of $300 million on lobbying and campaign contributions to preserve the $7-10 billion (20 to 30 percent of their earnings) they might lose with proper reforms of derivatives markets. Unfortunately, they have succeeded in protecting those earnings and left taxpayers bearing heightened risk that Wall Street recklessness will spill over onto them, forcing them to pay for another bailout.

We know what financial reforms are necessary; we just cannot expect the government to make them. That is why Spitzer’s discussion of core values, to my mind, suggests the path forward.

 People were angry when the government used their tax dollars to funnel money through AIG to Wall Street and bail out Goldman Sachs and foreign banks. The taxpayer was left with worthless shares of AIG when it should have held stock in Goldman and the foreign banks who were given a windfall. The discrepancy between a just outcome and the one we experienced engendered rage. Our core values were trampled.

Policymakers whine that they had to put out the fire, but everyone knew that they did not have to put it out precisely that way. And even if the bailout had to be structured the way it was, the unfairness of the outcome should have made policymakers run to Congress to enact emergency reforms on behalf of the American people. Society neither can nor should tolerate what happened with AIG: it was crony capitalism in raw form.

We cannot develop trust in any pillar of our society unless we openly express and credibly foster outcomes that are consistent with our core values. We must measure ethical outcomes, not theories of potential outcomes.

How do we do this? We might start by altering the incentives that elected officials face. We have to free them from the chains of fundraising so that they can enact good policy without committing electoral suicide. At the same time, we must demand that they give up the money blanket that incumbent insurance provides. Challengers cannot sell policy, only elected officials can.

At present I sense no urgency to make such changes. But the pressure can come when people start insisting that markets dominated by large, ungovernable firms, with government acting as their toadies, violate the essence of what the country stands for. Perhaps then we will be able to rebuild the true potential of government to correct externalities, enhance market integrity, and enforce the values we all hold dear.  ©