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Rex Nutting
Dec. 22, 2010, 12:01 a.m. EST
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By Rex Nutting, MarketWatch
WASHINGTON (MarketWatch) "” Top Republicans in Congress have learned nothing from the recent crisis about the risks of deregulated banks. Their blind faith in infallible markets is unshaken.
In recent days, the incoming chairman of the House Financial Services Committee, Alabama Republican Spencer Bachus, has been quoted as saying he believed the job of federal bank regulators and congressional overseers was to "serve the banks."
Congressman Ron Paul of Texas, who will head the subcommittee that has jurisdiction over the Federal Reserve, said he didn't believe any regulation was needed at all.
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Four Republican members of the fact-finding committee charged with discovering the causes of the financial meltdown that caused a great worldwide recession came back with a creative answer: It was all the U.S. government's fault; markets were blameless.
Such devotion to failed principles is inspiring, if not delusional. Markets are indeed wondrous institutions, but like all man-made creations, they are endowed with the same vices and virtues as their creators.
Many of us are taught at our mother's knee the Gospel of Adam Smith: Greed is good. It is not the charity of the baker that brings us our daily bread, but his self-interest. In this tale, we humans are motivated by only one thing: our own material needs.
And because our needs are insatiable but our resources are not, we have to have a system to ration the distribution of goods and services. Markets are the most efficient system we've found.
Adam Smith himself taught that markets were appropriate only in the economic sphere. But that hasn't stopped well-meaning reformers from expanding the reach of markets. We are told that our education system would be better if we used financial incentives to reward and punish students and teachers. We are told that our health-care system needs the harsh hand of competition.
This sounds like good advice in theory, but, in practice, education, health care and even finance can be ruined by the blunt application of market incentives.
US sky watchers enjoy a late night lunar eclipse on the darkest day of the year. Early Tuesday morning, those under clear skies across the US got a rare view of the moon passing through the shadow of earth on the winter equinox, which is shortest day of the year.Reuters
In an important new book to be published next month, "Practical Wisdom: The Right Way to Do the Right Thing," Barry Schwartz and Kenneth Sharpe of Swarthmore College show that, too often, giving people monetary incentives to do the right thing gets us exactly the opposite.
We can pay kids to read books, but only at the cost of killing their natural love of reading. We can pay doctors to reduce costs, but that might give them an incentive to refuse to treat the sick.
"When incentives are introduced into a situation, they can undermine other, better motives to do the right thing," Schwartz and Sharpe write. "Financial incentives can lead to demoralization "” in two senses. First, they take the moral dimension out of our practices; second, they risk demoralizing the practitioners themselves."
What do they mean by taking the "moral dimension" out of life? Simply put, we do many things because it's the right thing to do, not because it benefits us financially. In one example from the book, Schwartz and Sharpe report that a day-care center found out the hard way that once you destroy the moral reasons for doing the right thing, it's hard to restore them.
The day-care center had a problem: A quarter of the parents were late picking up their kids. The obvious market-based solution? Fine these scofflaws! But after the fines were imposed, about half the parents were late. Why did the problem get worse? Because the day-care center had changed the terms of the agreement. Before, picking up your kids was an obligation. But then they put a price on it, and many parents felt it was worth it to be late. Frustrated, the day-care center abandoned the fines, but it was too late. Parents had learned that being late wasn't a question of right or wrong, but only a question of price. And now the price was zero, so even more parents were late.
Turning every human interaction into a market relationship has a high cost. Even in the corporate world or in high finance, financial incentives can be counterproductive.
To get their employees to work hard and to pay attention to the firm's profits, most big Wall Street firms pay huge bonuses to their employees "” in many cases, the bonus is twice or three times the annual base salary, which by itself is far more than most working Americans could ever dream of.
But the incentive system isn't working well on Wall Street, as we all know. By paying bonuses based on short-term results, the firms rewarded employees whose actions did long-term damage not only to the firm but to the global economy.
It also turns out that the employees themselves are increasingly skeptical of the bonus system. As four professors at the prestigious Wharton School wrote recently in the Washington Post, their MBA students (many of whom already have put in time on Wall Street) believe bonuses are a crappy way to motivate employees.
Professors Peter Cappelli, Michael Useem, Matthew Bidwell and John Paul MacDuffie found that even Wall Street bankers want more from their job than a huge paycheck and an obscene bonus. They want to master their job. They want feedback "” positive and negative "” from their superiors. They want to be treated fairly. They know that what often earns the biggest bonus is often the thing that does the most long-term harm to the client, to the firm and to society.
From Wall Street to the neighborhood kindergarten, we need to foster the practical wisdom to help us to do the right thing, to be teachers who teach, doctors who heal, bankers who nurture capital, or journalists who tell the truth.
We want to do the right thing, but too often we are demoralized by the perverse workings of markets.
Rex Nutting is Washington columnist and international commentary editor for MarketWatch.
The initial reaction to the net neutrality plan is seen as positive for content providers like Netflix, but Comcast and others are unlikely to sit still for long
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