The Rationality of Spite: Why the Bailouts Do, And Should, Make People Angry


Wednesday, Oct. 01, 2008

Over the last several months, the federal government has bailed out Bear Stearns and American International Group (AIG) and taken control of Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Mortgage Corporation), thereby assuming risks and liabilities in the hundreds of billions of dollars. The Bush Administration has also asked Congress to (quickly) authorize the expenditure of $700 billion for a broader bailout of the U.S. financial system. There are some knowledgeable and wise people in the Bush Administration (and beyond) who believe that these moves are necessary to minimize disruption to our economy and ultimately, to protect taxpayers.

Other commentators have expressed the view that the bailouts will not improve matters and may actually harm our economy further. Some, however, though not expressly disputing the economic theory behind the bailouts, have expressed outrage at the federal government's willingness to spend enormous amounts of money to prop up huge private sector companies, when juxtaposed with its unwillingness to provide basic healthcare and housing assistance to ordinary people who have been facing catastrophic threats. Such critics believe that the bailouts are fundamentally unfair and reflect a kind of socialism for billionaires.

To the latter critics, defenders of the bailouts respond that it is irrational for ordinary people to oppose measures that would rescue our economy from potential collapse. After all, the broader disruptions that the bailouts avoid would harm everyone, including the unemployed blue-collar worker who has no health insurance and is losing his home. If the economy improves due to the bailouts, this person might find work, might be able to purchase health insurance (or receive coverage at his job), and might ultimately be in a position to afford to buy a new home (the value of which is more likely to remain stable in a functioning economy).

If one accepts the idea that bailouts will help the economy in this way, then isn't it irrational to oppose them? That is, can't we say of bailout opponents who cite the unfairness of "socialism for billionaires" that they may be cutting off their noses to spite their faces?

This column will explore the role of "spite" or - more charitably - opposition to unfairness (even at great personal cost) in people's behavior. It will conclude that those who oppose the bailouts because of "spite" are not necessarily behaving irrationally, if we consider analogous choices in our legal-constitutional framework.

The Ultimatum Game

Some say that human beings are rational creatures who predictably act to maximize their own economic wellbeing. But the ultimatum game is an often-cited counterexample. The game is actually a social psychology experiment that involves two subjects, the "proposer" and the "responder." The experimenter offers the subjects an endowment, such as a cash prize, to be divided between them. The proposer then has the opportunity to "propose" an allocation of the endowment (e.g., 50/50, 70/30, etc.), and the responder may then decide whether to accept the proposer's allocation (which will result in the endowment being allocated accordingly) or reject the proposer's allocation (which will result in both subjects receiving nothing). In most cultures, including our own here in the U.S., responders consistently turn down endowments when proposers propose unequal allocations that disproportionately favor themselves (e.g. 70/30 to the proposer). We will call those who do so "rejecters."

To turn down an endowment under these circumstances is to act out of something akin to spite. The rejecter's thinking goes like this: If that other person - the proposer - is going to be greedy and try to get more than his fair share, then I will punish him and make sure he gets nothing, even if it means that I too get nothing.

Some economists classify rejecters' behavior as irrational, because they give up a benefit (the 30 percent share) in exchange for nothing at all. At least in the experiment, the participants are anonymous and will not be paired with each other again. Therefore, even if the proposer "learns his lesson," the responder will never know it and will, in any event, enjoy no personal gain from the results of the lesson.

Rational Spite

But has the rejecter truly behaved irrationally in refusing to accept the 70/30 allocation? One could say that he gets more than he pays for in revenge or retribution. If the rejecter was going to receive $30 free of charge, for example, then he effectively spends $30 to penalize the proposer and receives $70 worth of satisfaction for the price he has paid - that is, he deprives the transgressing proposer of more than twice as much money as he gives up to bring about that well-deserved deprivation.

Other kinds of retribution cost a great deal more. The rejecter's approach to the ultimatum game may seem the picture of efficiency compared to the creation and maintenance of prisons, which cost the taxpayer large amounts of money (due to the expense of security intended to prevent and frustrate attempts at escape, as well as the expense of providing for prisoners' basic needs). Nonetheless, people are willing to spend money to make criminals suffer for their crimes, even when there is no real likelihood of rehabilitation. And few of us consider retribution an inherently "irrational" project, even if we do not all support particular law enforcement agendas, such as the War on Drugs.

Another instance of our laws depriving one person of an unearned benefit on behalf of another person (who will also receive none of the unearned benefit) is the principle of equality embodied in both the U.S. Constitution and the federal and state statutes that prohibit discrimination. If government actors open a public library with racially-differential access to books, those who run the public library - if sued - will be ordered to do one of two things: either afford racially-integrated and equal access or close the library. If integration is unacceptable to them, then the library will have to close and - from a wealth-maximization perspective - both white and black patrons will lose. The same can be said for employers who insist on discriminating, despite its illegality: they will be unable to employ anyone, and all of their would-be employees will, in some sense, lose.

Yet many (perhaps most) of us do not consider these losses a reason to be skeptical of anti-discrimination law. Such laws (and their supporters) take the view that unfairness taints an enterprise sufficiently to make the continued existence of that enterprise less important than it might otherwise have been. Because of the law, employers and government officials can foresee the demise of their enterprise if they choose to behave unfairly and discriminate. This may motivate them to act fairly (and perhaps, over time, to view equality in more favorable terms) or it may not, but the injustice of discrimination calls for retribution, even when there is not a resulting gain in wealth at the end of the rainbow.

Applying Fairness to Wall Street

One could say that unlike discriminators and criminals, the federal government - in the case of the bailouts - was not "on notice" under the law that there would be a strong negative public reaction to perceived unfairness, even if the government bailouts made good wealth-maximizing sense. But this statement about notice assumes that we need a law to tell us what is and is not fair. The reality is that one might reasonably view the federal government's "free market" approach to poverty, health crises, and foreclosures as fundamentally inconsistent with bailouts of Wall Street - as a lopsided allocation by champions of the wealthy to their wealthy friends that, to some minds, mirrors the already-skewed distribution of wealth in the U.S.

For people who take this view, the fact that they personally might have suffered marginally more if there were no bailouts than they otherwise would does not - and maybe appropriately does not - make them favor the bailouts. Their sense that Wall Street must pay for its mistakes - even if this costs the rest of us too - may be powerful and rational, at least as rational as the human desire for retribution and equality embodied in our criminal justice system and anti-discrimination law.

Sherry F. Colb is Professor of Law and Charles Evans Hughes Scholar at Cornell Law School. Her book, When Sex Counts: Making Babies and Making Law, is currently available on Amazon.

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