by Brian Brady
Commercial Real Estate Finance Expert
Structured Debt and Equity
Licensed Real Estate Broker in AL, CA, and FL
Sarah Palin is so suspiciously quiet this week as is President Obama. We’re all kind of holding our breath, as the oil spreads throughout the Gulf of Mexico, with hopes and prayers that it doesn’t reach the Panhandle beaches. This oil spill is big and its effects might be catastrophic.
This is not a failure of the free market rather it is a failure of government.
Greg Swann beat me to this yesterday, encouraged by an email from Sara P,. Miller, but I’ve been talking about this on Facebook for a few days:
There is no need to ban offshore drilling. Present BP with the cleanup bill and hold them responsible for the secondary damages, and other oil companies will think long and hard about the costs associated with offshore drilling. If the US Gov’t “bails out” BP by socializing costs, it will be one more example of how gov’t makes the world a less safe place than the free market can
This may be a hard pill for government groupies to swallow but the response to the Exxon Valdez oil spill (more government regulations and a limit on liability) is what caused this disaster. Regulations offer a false sense of security. Moreover, when the State manages risk for private industry, private industry will take as much risk as they are legally permitted. It happened in the housing market and now its happening to our environment. This is what free market supporters call “moral hazard” which is a fancy way of saying “with reward comes responsibility”.
We didn’t like the Valdez oil spill but let’s face it: that was in Alaska. It affected far fewer people and its cold there so you (and I) didn’t think too much about it. Now that the chocolate milk is threatening our prettiest beaches, in a warm clime, with millions of people affected, we’re nervous….and it might have been averted had the State not encouraged what might be VERY risky behavior but we’ll never know…
…because that risk was socialized by the taxpayer.
Let me show you how it happens:
Senator Sara is elected from a state like, oh…California. She knows her constituents are addicted to cheap gasoline so that they can jam pack the government-subsidized freeways in LA. Still, ecologically-concerned citizens in San Francisco worry about offshore drilling because of the Valdez disaster.
Oil industry lobbyist Brian notices Senator Sara’s conundrum and exploits it. He approaches Senator Sara with a deal: voluntary industry submission to government regulations, written by people who don’t know a BOP stack from a stack of pancakes and his influence with the Senate Whip so that Senator Sara gets a committee Chair. In exchange for that deal, Senator Sara supports a liability cap (in the name of national security) and an industry pledge to stay away from the California coast. As a bonus, Lobbyist Brian agrees to a long-term contract hike with a labor union.
Then another oil spill happens. Senator Sara promises to make ABC Oil pay the maximum penalty on the Sunday morning talk shows. Senator Sara reaffirms her commitment to more government oversight and is jubilant about the new jobs, created from the “public/private partnership” formed to clean up the mess. Lobbyist Brian wires the limited liability claim to an escrow account, calls the Wall Street analysts to let them know everything is kosher, and tells the CEO of ABC Oil to look penitent on television.
The result? An extraordinary transfer payment to the oil industry from…?
The American taxpayer. Oh, and more oil spills will happen, too.
The solution? Government should do one of its two legitimate functions and adjudicate the claims. The judgments will properly quantify the risk associated with an oil spill so that the industry can better measure that risk. Maybe all offshore drilling will cease. Maybe new technology will be developed to bring the oil through the water safely. Maybe reinsurance products will be developed to diversify the risk. …but we’ll never know. We’ll never know because Senator Sara and the rest of the superheroes in Washington are certain that they can corral what Adam Smith called “The Invisible Hand”
Government has failed at every economic venture it touches. Ask the Postmaster General or the Oil Industry Czar why it is impossible to pursue profit while buying votes. Now, its meddling might destroy our nation’s prettiest beaches, threaten our food supply, and promote bad business behavior.
Alex Cortez says:
The American taxpayer subsidizing yet another mistake by the private industry. This is getting tiring. Any bets on what industry will take advantage next?
May 4, 2010 — 4:39 pm
Don Reedy says:
Brian,
So very well put. You’re not waving the “BP oil guys are wrong” flag. You’re not waving the “BP oil guys are victims of an accident flag.” You’re astutely waving the “humans will push the limits of the legal system to their benefit flag.”
In this case, the legal system is (and will be) played so that the advantage goes to the government (hey, we’ll squash these guys and protect you in the future), and also to the oil companies, who used to be free market players, but now have gamed the systems to limit their liability.
As I find myself increasing saying (to coin Greg Swann’s line in his latest post on this)….we’re screwed. Regulation, over-regulation, limits on regulation, Regulators and bureaucrats with not so much as a tar stain anywhere on their hands have written the story of how to undo the free market.
It won’t be popular, me thinks, but governmental activism is the culprit. It’s not hard to see if you look for it. But even if you do, it’s harder to see how we’ll be able to undo not just the damage to the environment from this accident, but the damage to all our freedoms from the activism that seeks to choke off the true free market.
May 4, 2010 — 4:55 pm
Robert Kerr says:
RE: “This is not a failure of the free market rather it is a failure of government.”
You appear to be serious!
That’s quite a stretch, Brian.
May 4, 2010 — 9:25 pm
jeff Brown says:
You’re preachin’ to the choir with me, Brian. However…
Am I the only one who smells a rat here? The timing was too perfect. This is exactly something I’d do if I was a terrorist OR one of the green-freak extremists.
We need to put blame where it’s due, and if it’s the oil company, they should pay — period. But let’s not discount the possibility of sabotage.
May 5, 2010 — 9:05 am
Mike says:
Or they will simply not operate any rigs directly. They will form a separate company for each one. Then, when a disaster happens, that one company goes under. Then what?
The free market is no more a panacea than government is. Ultimately they are both run by people. Until you can find a nation of people that are all smart, hard-working and moral, there will be problems.
May 5, 2010 — 9:33 am
Greg Swann says:
> They will form a separate company for each one. Then, when a disaster happens, that one company goes under. Then what?
> The free market is no more a panacea than government is.
What you are describing — accurately — is not a free market but Rotarian Socialism. Liability limitation can only be done by force of arms — government — not by entrepreneurs.
May 5, 2010 — 9:42 am
Mike says:
1. I form a company.
2. BP invests in my company and I use that capital to build an oil rig in the Gulf.
3. I give BP stock, including preferred stock which pays a healthy dividend.
4. My oil rig explodes creating a massive oil spill.
5. I can’t afford the clean up so my company goes under.
6. BP loses the money it had invested in my company, but nothing more, and has absolutely no responsibility for the clean up.
That’s not liability limitation. That’s free market capitalism. Even if 100% of the start up capital comes from BP, what system could ever hold BP responsible? And if there were such a system, then would every BP shareholder also be held liable?
May 5, 2010 — 10:56 am
Greg Swann says:
> Even if 100% of the start up capital comes from BP, what system could ever hold BP responsible?
An actual justice system, as compared with elaborately-organized crime. The owners of a business are liable for the damages they cause, except where their liability has been artificially limited by force of arms. This is what the corporation style of business organization is for — to reap all the profits but to socialize most of the losses to people innocent of all wrong-doing — the victims of the damage first and then the tax-payers.
> And if there were such a system, then would every BP shareholder also be held liable?
Obviously yes — to the full extent of their assets, and, ultimately, to the full extent of the damages.
You next question is, “Why would anyone invest in a business where the investor can be held liable for events over which he has no control or oversight?”
The answer: No one would do that. And that’s good, because disasters like this would almost never happen if investors were held fully liable for their risky behavior. Corporate investors are much less risk-averse than true entrepreneurs precisely because their liability is limited by criminal fiat of law.
> That’s free market capitalism.
If there is an armed functionary of the state forcing you to go along with something you would otherwise choose not to do — such as paying out of your own pocket by taxation for BP’s error — it’s not a free market. Political freedom means freedom from coercion. Nothing else. If the investors in British Petroleum do no undo the damage they have done at their own expense, then that expense must be socialized by force to someone else. There is no middle ground between justice and crime — and for damn sure the name for the crime we are witnessing is not Capitalism.
May 5, 2010 — 11:12 am
Greg Swann says:
Not to put too fine a point on it, but the next argument is a sequence like this is almost always a form of the broken-window fallacy. Yes, we are rich despite the many crimes Rotarian Socialists have committed. But theft, waste, currency manipulation, subsidies, malinvestment and other economic crimes occasion opportunity costs — the profitable investments that could have been made with that money, were it not being stolen for the benefit of politically-connected grafters. And each one of those opportunity costs incurs a compound-interest cost, going forward. The issue is not how rich we are even though we live in a well-dressed Mafia cartel. The issue is how much richer we might have been, by now, had we behaved honestly all along.
May 5, 2010 — 11:43 am
Mike says:
Great response Greg! The idea of holding shareholders responsible is especially interesting.
Before I would ever invest in a company, I would need to be compensated for the risk that I could also be held liable. So I would demand a big return before I invested in, say, an offshore oil company or tobacco company.
This means the cost of their products would need to go up, reflecting the true costs of doing business.
I need to let it digest for a while, but you might have convinced me!
May 5, 2010 — 12:37 pm
Greg Swann says:
> I need to let it digest for a while, but you might have convinced me!
I’m stunned. That never happens. 😉
If I don’t scare you away completely, you might give a look to this post on the viability of a coercion-free human civilization.
May 5, 2010 — 5:22 pm
Brian Brady says:
“This means the cost of their products would need to go up, reflecting the true costs of doing business.”
Maybe not. Read through the linked broken window fallacy, by Bastiat. Product costs may actually drop because you’d eliminate some expensive procedures: legal costs, accounting costs, regulatory compliance costs.
“That’s quite a stretch, Brian.”
In the world Greg laid out, do you think it more or less likely that businesses would pursue risky projects without limiting the damage they do?
May 5, 2010 — 1:25 pm
Jim Klein says:
“Before I would ever invest in a company, I would need to be compensated for the risk that I could also be held liable. So I would demand a big return before I invested in, say, an offshore oil company or tobacco company.
“This means the cost of their products would need to go up, reflecting the true costs of doing business.”
Exactly right, and those are only the practical benefits! Ultimately, shielded liability is the assertion that some entity is doing something, and that this entity is comprised of something other than individual people. Being a false assertion, it should be rejected out of hand because no good can possibly come from accepting false assertions.
May 6, 2010 — 3:27 pm