The Economic Pitfalls of a balanced Budget Amendment to the Constitution.

All over the world, the present stymied state of the economy seems to have provoked the atmosphere in which ideas of various sorts are discussed to solve the recurring problem of budget deficits in some of the notable National Economies.   Particularly in the United States of America, the most prevalent and loudest idea espoused by most Conservatives-leaning thinkers is the imposition of a balanced budget on the Federal Government via a Constitutional Amendment. Innocently as this idea of balanced budget Amendment seems to be, the nagging question for inquiring-minds is “is it the best solution available?”

Regardless of the good intentions of the proponents of a balanced budget Amendment, it will be a disastrous political action to take to solve this complex economic problem.   Yes, common sense would have us believe that that is the most viable solution for the Country since we as a Country cannot seem to control our spending or balance our budgets.  Unfortunately, common sense is not a well known economic principle, which can be trusted to adequately describe the economic generators of budget deficits.  However, the common-sense nature of the approach seems to appeal to a lot of people, who may have considered it a panacea or a lasting and universal solution for the problem the Nation faces.  In any case, this problem is induced primarily by prevailing economic conditions; hence, requires and would respond better to economic solutions than to political tinkering.  In fact, budget deficits and surpluses are byproducts of economic cycles, which are inevitable so long as economic forces determine our economic behaviors.   Therefore, it is near impossible to just legislate away inevitable economic byproducts. Additionally, most economic problems do not often respond very well to common-sense solutions.  Most often, common-sense economic solutions make sense on the surface, but are rarely supported by veritable economic principles; hence, they usually will encounter implacable implementation processes and untenable feed-backs needed to monitor and correct problems that may arise during the implementations phase.

Naturally, if like many State Constitutions, the Constitution of the United States of America demands Congress to balance its annual budget, Congress shall have no choice but to abide by such an unnecessary imposition.  Like the States, Congress will be forced to take a number of economically detrimental steps to abide by such constitutional Amendments.  A number of these steps may involve laying-off workers, freezing spending, canceling some scheduled projects and even withholding funds for military and non-military actions. Unfortunately, even though most of these steps are taken to pacify the constitutional requirement of a balanced budget Amendment, they will only have detrimental effects on the Economy. In short, they will only lead to the contraction of the Economy; hence, they will aggravate the problem that they are meant to solve.  Anyone who cares to find out about the consequences of such an Amendment should look no further than noting the economic upheavals festering in the various States that have balanced budget constitutional Amendments.  In order to meet their constitutional Obligations, such States often resort to laying-off their State workers, delaying necessary infrastructure repairs, cutting educational Aids to their Schools, cutting and eliminating some social programs that are intended to help their less well to do citizens, while at the same time spending more funds on unemployment benefits with reduced tax-base.  This knee-jerk reaction by the State Legislatures, when faced with mandated balanced budget, is also expected to be adopted by the Federal Legislatures if faced with same alternatives.  Consequently, like the Economies of the States, the Federal Economy will suffer a retracted economic recession.  Undoubtedly, under such economic situations, the intelligent economic policy to undertake is to invest rather than reducing investments.  Importantly, it should be understood that Economists define an Investment as a delayed consumption, and most federal government expenditures are considered delayed consumptions or “investments.”  Thus, most outlays by the federal government should not be considered immediate consumption or outright spending.

Never the less, some individuals, mostly conservative-leaning thinkers, argue that in such economic situations, Government should retract spending, and get out of the way of businesses to let the economy fix itself.  Worse still, such individuals argue that what the economy needs most is tax reliefs and deregulation to allow so called “Job-Creators” to create more job opportunities in the economy. Of course, these assertions are loaded with hard-to-verify economic assumptions.  First and foremost, the so called Job-Creators, given such tax reliefs, may not choose to spend them in creating jobs. What or who will compel a so called “Job-Creator” to employ a single job-seeker if he/she is not legally obligated to do so?   Besides, at a time when interest rates are as low as ever observed since the 1970’s, why would a corporation want to rely on tax reliefs to raise funds to finance its efforts to exploit available opportunities?

Economic principles hold that most for-profit businesses do not create job opportunities out of patriotism. Usually, they do so because economic demands for their goods and services prescribe such actions.  In other words, without demands for goods and services of a business organization, no amount of tax incentives would make good business managers hire the next employee. Similarly, Government deregulation will not make any difference in encouraging businesses to hire more people if there is no economic demand for their goods and services. None the less, conservative-leaning individuals continue to insist on the same old and failed economic policies to cure the direct effects of those failed economic policies. Incidentally, one interesting question to ask ourselves is what are regulations and why are they necessary or unnecessary?

Business regulations are nothing but rules or guidelines on how to properly conduct business in any sector of the economy. Often, they establish fair or level-playing fields for all participants in the particular sector(s).  They serve as the legal boundaries of operation.   Consequently, the government should be the arbiter and responsible for making, supervising and punishing offenders or violators of such boundaries.  The Government is the right entity of the system to act as an arbiter because it has equal stakes in all participants of the economy.  Therefore, every reasonable person would not seriously refute the argument that the government would make rules to deliberately thwart the efforts of businesses or any other participant(s) of any markets.  In fact, the primary function of the government is to serve and protect the interests of all its citizens. Thus, a reasonable assumption is that the government will not seek to institute laws that hinder or impair or impede any legitimate business activities.  Most often, the government only responds to contemporary economic situations, which call for necessary legislative actions on the part of the government to ensure that such situations do not reappear to affect the economy adversely.

To answer the question why regulations exist, an Illustration is clearly called for.  Before the direct involvement of the government in banking services, some unscrupulous bankers often set up banks in different states and promptly left “town” stealthily after collecting the deposits of their unsuspecting customers. Often such marauders who claimed to be bankers ran to another States or to the Caribbean Islands to enjoy their loots.  Meanwhile, their victims were agonizing over their losses without any recourse.  Imagine yourself depositing five thousand dollars in your bank account the previous day, to find yourself penniless the next day because your bankers had left town in the middle of the night.  Worse still, you had no idea who to turn to in order to retrieve your money.  Subsequently, a lot of the victims ended up killing themselves as a result of the sudden and unexpected economic awkwardness in which they found themselves.  Neither their State governments nor the Federal government was of any help to them.  So rampant was the incident of theft of deposits in the Country that the governments, both States and Federal, got into the business of writing guidelines or rules or regulations to confine the activities of the financial systems for their own good.  Most often, business regulations are there to protect business organizations from self-destruction.

Another case in point is the recent economic debacle suffered by the Financial Systems.  Even in this case, the irony is that, some individuals blame the government for the massive failure. In any case, the primary culprits are the large banks.  Primarily, banks obtain their income from two sources: interest income, which accounts for about 85- 90% of their total income, and fee income.   However, leading to the debacle, most of the large banks seeking to increase their income resorted to increasing the contribution of their fee income mainly to avoid any unnecessary   repercussions from Congress for such actions. However, with Congress less likely to respond adversely to fee increases, banks saw fee revenue as their pot of gold.  Furthermore, just around this time, a new bank product or innovation called “securitization” – converting illiquid assets such as bank loans into liquid (easily sold or convert to cash) assets   became the darling of the large banks, which are now allowed to exploit investment banking activities (a direct result of the repel of Glass- Steagall Act, which previously prevented commercial banks from offering investment bank or insurance products).  Consequently, large bank-created financial assets such as: Collateralized Debt Obligations (CDOs) and Collateralized Mortgage Obligations (CMOs) of various flavors were introduced   into the financial markets.   To achieve maximum and full exploitation of those innovations, the large banks cornered the Housing markets by creating Mortgage Houses to solicit Housing loan applications from every breathing person (regardless their financial statues) who was willing to buy a home, they could find, in every corner of the country.   This created an atmosphere of unsupervised competition among the Mortgage Houses.  Moreover, some of these Mortgage Houses or banks were doctoring the application forms for potentially incompetent home buyers. These Banks or their Mortgage Houses in many cases inflate the take-home Incomes of loan applicants for the purpose of qualifying such borrowers who may not be able to pay back the loans.  In other cases, the banks offered such borrowers low but variable interest rates in order to get the upfront fees from such customers.   By all known standard of the financial system, these practices are unacceptable, outrageous and are nothing but a total remiss of the fiduciary responsibilities of the banks, at the least.   Banks are expected to vet their borrowers thoroughly (often referred to as due diligence) before granting any Loans to such borrowers.  However, during the time of this unsupervised competition by the various Mortgage Houses, most of the banks failed to follow their prescribed due-diligence process.  No doubt, this process was not strictly followed by these banks in part because the Government of the time, the Bush Administration, which like most conservatives believe in fewer regulations (often referred to as “Free Market Principles” in conservative circles) encouraged the government supervisors to look the other way while `these banks were raiding the economy of the country for themselves.

Contrary to the belief of most conservatives about financial markets, the undeniable fact about financial markets is that   nothing is free in financial markets.   In short, forces of reality make it impossible to find a single characteristic of financial markets that is free.  Only in graduate school would one come across the term “Perfect Markets,” but those are ideal markets, which could not exist in real World. I would assume that any doctoral student is well aware of that impossibility.  Yet, many conservatives tend to believe vehemently in the hoax, which is aptly called “Free Market Principles.”  One question I would like pose here to every reader is “has anybody ever obtained any free item(s) from any markets?  Quite possibly, what many conservatives often called “Free Markets” are some particular forms of theoretical markets known as “Frictionless Markets,” which are a variation of the “Perfect Markets.”  However, even the idea of “Perfect Markets” seems to be impossible to obtain in reality.  Simply put, this idea of “Frictionless Markets” implies that there are no transaction costs, no taxes, information is readily shared freely, and of course, no government regulations in such markets.  Obviously, when Conservatives say “Free Market Principles” they really mean “Government Free.”  But no markets can survive without the government.  Unbeknown to most conservatives, the government is not only the most important participant in the Markets, but it is also the biggest and safest participant of all.   The government like an invisible Soul is the sole lifeline of any markets.    Government agencies are the creators of the rules of engagement, the supervisors, and the arbiters of the markets.   Consequently, the government is the primary source of the discipline that seems to be inculcated in the markets when everything is working correctly or running the manner it should.  The so often trumpeted “invisible hand or the divine Mind of the market” is nothing but the various moderating roles or influences of the government. Nonetheless, it is reasonable to assume that most conservative-leaning thinkers will strongly disagree with me about these assertions.   But, I am equally fixed in my position that there is no “Divine Mind” that controls the markets as it sees fit.  Unless, it is proven beyond any doubts that such a “Mind” exists to control the capital markets exclusively, I intend to stand my ground.

Most importantly, the efficient functioning of the financial systems is based on the idea that each participant of the markets will play their roles honestly.  Specifically, the financial institutions such as commercial banks and others, which generally produce market related information, are expected to perform their duties without reproach. However, in this case, the banks (the large banks) allowed blind greed to overrule their best judgment.  Clearly, this was the point where the government agencies supervising the banks should have intervened, but the government of the day failed miserably to arrest the emergent situation immediately.  Let me emphasize this point beforehand that I have no qualms with greed so long as it is supervised.  In fact, greed as I understand it is the tendency of rational market participants or anybody to prefer more to less.  It is a natural urge in every rational being not to short change oneself.  I am utterly convinced that it is greed that motivates every economically rational individual to participate in any economic ventures.  However, greed without any supervision in any market structures is tantamount to blatant market failure or destruction.

For further emphasis, no economically rational being will turn down a $10 gift for a $2 one if the risk or effort involved in both is the same. This is what I mean by supervised greed, and all of us are endowed with it. If however, an individual chooses to go beyond the rules of the game by grabbing both prices that will be considered unsupervised greed (Selfishness).    Shamelessly, these banks involved in this racket, understood one thing and only one thing that is that by securitizing the loans they shifted all the inherit risks of  the financial assets,  so created, to other market participants who might have bought these securities in good faith (believing that the banks were honest and truthful in carrying out their duties).  Unfortunately, the selfish nature of human beings, which often reveals its ugly head when there are no guidelines to punctuate our conducts, permitted the consequent conducts of the banks, which ultimately brought down the entire financial markets and hence the economy of the country.   It is true that such blatant and colossal manipulations of the markets have a very low probability of occurrence, but as we observed in this case, they will take place when market supervisors are reluctant to do their duties promptly. These are some of the reasons we need market regulations, if for nothing else, to maintain the sanity of the markets.   Importantly, there are many quarks like me who play the markets solely to beat everybody else, even though those who studied  financial markets at the graduate level are well acquainted with the fact that in the long-run none can consistently beat the Markets unless with insider-information.

Overall, my thesis is that it is unwise to attempt to solve purely economic problems with only political solutions.  It is however naive to think that politics will not have any influence on any national Issues, whether economics or otherwise, but letting politics dictate the course of action in such an important and fundamental economic Issue as deficits is unfounded and unwise.   After all, budget deficits are consequences of the variations of economic forces (economic cycles) in conjunction with government layouts.  In fact, during some economic cycles, the vagrants of economic forces could exaggerate the budget even when government layouts are fixed.  Therefore, it makes little or no sense to attempt to solve a contemporary economic issue with a mandate that may not take into consideration the contemporary economic conditions of the time in question.

Fortunately, one brilliant characteristic of the national Constitution is that the founding Fathers never attempted to restrict the economic decisions of the next generations of American leaders by not codifying such stupidity in the Constitution.   Unlike the present generation, they seemed to understand the fleeting nature of economic variables, thus rightly relegated that authority (the authority to make the right and proper economic choices) to the current leaders facing the contemporary economic conditions. It is therefore my hopes that we, the Inheritance of this Constitution, do not seek to impose our ignorance of economics on the future generations of Americans.

Lastly, it is my sincere hopes that given the disastrous effects such a constitutional amendment is likely to have on the national economy cooler heads shall prevail in derailing the efforts of the ill-informed amongst us to wreck an ever forward-looking economic structure in the world.   However, if we happened to stoop so low to enact such a statue, the warning for other national governments that may want to follow such an idiotic step is “DON’T BE STUPID.”

By Promyse Ibim Benibo, Ph.D., Finance