In other words, what's good for individual banks and lenders is bad as a system, and so the markets need forceful intervention from a regulatory body. Now, Jim Manzi's true-blue capitalist cred is unimpeachable. As are those of the many i-bankers, venture capitalists, moneymen and corporate heads who have been applauding this near-nationalization of banks through direct investment to improve short-term solvency. So I don't think this is an example of just those who (like me) are inclined to be skeptical of some aspects of capitalism crowing about a turn towards socialism. I think it's a fact of most people who are invested (literally and figuratively) in the system on Wall Street recognizing that the best remedy for this problem involves ventures which might not fit with their usual ideological preferences.
Capitalism, after all, is the great adapter. I've idly wondered if a turn towards socialism might come not from a new peoples revolution, not from the ballot box, and not by government fiat, but through the capitalists becoming convinced that a socialist turn would be best for business. Of course, that's a hypothetical, largely, at this point. But it's possible. Capitalism has no ideology, it just has the profit motive, and I believe that if it became apparent that some system of government controls of wealth and industry led to greater profits, the Larry Kudlows of the world would run smiling into the arms of Trotsky.
As libertarians go, I'm relatively in favor of financial regulation. But I think there are two ways to think about financial regulation:
1) Wall Street people are tricky bastards who spend almost all of their time thinking of how they can best maximize their profits by screwing The Little People. They must be rigidly controlled so that they cannot do most of the things they want to do, because almost anything they want to do is definitionally a bad idea. It wouldn't hurt to punish them occasionally, for being such tricky, selfish bastards and taking all that money they don't really have any right to. Most financial activity is useless paper shuffling that adds no value to society anyway, so there is no downside to clamping down on the banking system with an iron fist.
2) There are multiple possible equilibria in financial markets, and one of the problems in those markets is that decisions which are individually highly rational can, in aggregate, move society to one of the bad equilibria. Worse, those decisions may be sticky--it may be much harder to get out of the bad equilibria than into them. The government should act to mitigate the systemic risks by doing the things that only it can do: enforce transparency, solve collective action problems, and analyze the system for systemic rather than local risk. This will necessarily involve sacrificing some potential upside in order to insure against catastrophic downsides. But the government must remain aware of its own tendency to be excessively risk averse, because regulators are punished for visible failures, but not invisible lost benefits. It must also worry about the way that the very regulations intended to ensure safety can create or enhance systemic risk, as has happened in this crisis with rules such as the mark-to-market rule, and various institutional requirements for high credit quality in investments.
Needless to say, I think the second approach is better. Unfortunately, in crises like this, the general political attitude is closer to the first one.
Moreover, it seems to me that at least some of the people who are tremendously excited about the prospect of regulation are not excited because they are worried about the health of the financial system so much as they are intoxicated by the power that greater regulatory authority might give a liberal government to advance other goals, such as redirecting capital flows to more "deserving" uses, or reducing income inequality. To the extent that you wish to reduce income inequality, there are much better ways to do it than crippling your banking system so that bankers can't get rich. And the aggregate record of governments at directing capital flows in welfare-enhancing ways is, to put it mildly, abysmal. Nor is there any evidence that the US government is better than average at making investment decisions--rather the reverse, in fact, since 540 legislators all want a piece of the action.
I think this is a very good time to strip down our regulatory system to its bare bones and rebuild it into something more effective: streamlining regulatory authority, refocusing it on systemic risk and giving it the power to pursue those issues more effectively, purging the overreliance on single models that make things more convenient for the regulators, and figuring out how the hell Basel II went so deadly wrong.
But I do not think that this is anything close to what we will actually get. We will get piecemeal patches designed to prevent the problems that just occurred without much attention to future issues (see, Enron and mark-to-market accounting). We will probably see restrictions on various types of activity, without regard to lost upside from that activity. There may well be some dramatic and pointless gesture, such as Glass-Steagall's drive to split off investment banking from commercial banking. I expect some populist measures like letting judges rewrite mortgages in bankruptcy, which look swell until the cost of a mortgage goes up. And we will very certainly increase the amount of paperwork that companies and financial institutions do, creating a larger mountain of data that our current regulatory structure will be unable to intelligently sift through. As a side effect, it will raise the barriers to entry in both the market for public funds, and the financial industry, further consolidating power among the remaining incumbents.
This will make happy those who are definitionally in favor of more regulation. But this approach sets up a direct tradeoff between growth and safety; in order to get more safety, we give up a lot of financial activity which ultimately reduces the supply of capital. I don't think that's necessary. A lot of people writing today seem to think of regulatory agencies as quasi-prisons for Demon Finance, and think that the main problem with the current system is that it's mollycoddling the inmates. Bankers are not criminals. As a class, they are exactly as self-interested, self-destructive, and short-sighted as other classes of people that liberals want less highly regulated, such as unions and community organizers. I don't view the purpose of regulation as punishment, or protection against a malevolent class. I view it as an attempt to make our institutions more effectively channel self-interest into collectively welfare-enhancing activity. Thus you can see why I might be somewhat uncomfortable with those who seem to view the crisis as an exciting opportunity to put those uppity bankers back in their place.
It is true that capitalism is ideology-free in the sense that it pursues profit wherever it may be found. However, privatizing profits on the way up but letting the taxpayers pick up the losses on the way down is bad policy. At the rally against the bailout on Wall Street one person held up a sign saying "My Taxes Are Not Venture Capital." That puts it very nicely, I think.
I believe that if it became apparent that some system of government controls of wealth and industry led to greater profits, the Larry Kudlows of the world would run smiling into the arms of Trotsky.
That's not exactly a theoretical risk. It even has a couple of names: rent-seeking and regulatory capture.
But to be clear, to get Larry Kudlow on board, you'd have to show higher GDP growth, not higher profits. He's not going to favor a government-enforced monopoly on anything, even if the profits would be higher for the winner.
Yeah, we should hope for more of any system which results in the Chairman of the Senate Banking Committee having a son who works as a lobbyist for one of the largest institutions the Chairman ostensibly regulates! Woo Hoo!
Obama/Biden; change we can believe in!
Wait a second! What can one mean here by 'ideology'? Isn't it Marxism that claims to transcend ideology? Capitalism's ideology is screened by denial, but, in the marxian models it sure has one!
Of course, in a world where people like Ms. Pelosi and Mr. Biden can call themselves faithful Catholics, serious definition of things like "ideology" and "membership."
One can only shudder at the regulations (social engineering) that Dodd, Franks, and Maxine will write .
But you missed the other big potential problem, money can flow anyplace. Senator Obama has made many claims about Senator McCain pushing jobs overseas. But if regulatory burdens become a problem in this country, Ireland and India would be happy to welcome all the financial jobs fleeing the United States.
"I believe that if it became apparent that some system of government controls of wealth and industry led to greater profits, the Larry Kudlows of the world would run smiling into the arms of Trotsky."
"Trotsky" is taking it a bit too far, but one thought I've had in the past is that there's probably less political risk for investors who buy shares of, say, Total than there is for investors who buy shares of ExxonMobil. It seems to me that there might be less chance of the government screwing over shareholders if the government is a shareholder too.
Let me be clear-- any liberals cheering the full extent of this crisis, and not just the chance for us to pin back the ears of overindulged bankers and banks, are fools. If the kind of collapse that could happen happens, it would be a massive blow to our nation's poor. And the project of American liberalism would become harder, not easier. We'd be less likely to see universal health care, less likely to fix our immigration problems (one way or another), we'd see damage to worker's rights, and poverty and income inequality would get worse, not better.
"I've idly wondered if a turn towards socialism might come not from a new peoples revolution, not from the ballot box, and not by government fiat, but through the capitalists becoming convinced that a socialist turn would be best for business."
It's not exactly news that "capitalists" are usually in favor of all sorts of regulation, provided only that it gives them an edge over their competitors. Much of the New Deal consisted of giving businesses monopolies or cartels, which was good for them but bad for the country. The earliest minimum-wage legislation was blatantly a pro-North (and white) and anti-South (and black) move, since it raised the costs of industries relying heavily on unskilled labor. Assuming that business people are free-market ideologues is just wrong.
Too many forgot that our American success came from a moderate, regulated, market economy.
The "free market" cry was for unabashed and unlimited free markets.
I too welcome a return to moderation, but I don't see those in control of the Republican Party ready to engage on that. They are still fighting the "free market" war.
As one of the few people who would actually be willing to take on the mantle of being something of a Marxian, I have to perversely note that highly regulated capitalism is not socialism at all: it's highly regulated capitalism. It isn't as if the modern nation-state was sitting around Being All Governmental when suddenly capitalism popped up and wished all that bad government would get out of the way of the good times: the nation state as we know is very deeply and profoundly a product of capitalism and has served it quite well, doing everything from making sure its workers are educated just enough, that labor is made migratory within national boundaries but not (excessively) across them, doing all the monetary stuff that you know and love, etc. The modern state is made of capitalism, and capitalism is made of the modern state. Socialism is a statist enterprise as well, but it isn't synonymous with the state.
What makes me a quasi-Marxist is that I refuse to give up on class analyses in these matters. Wall Street is a pool of specific interests, and the financial crises hits different groups differentially.
It's interesting to compare the words used in Cases 1 and 2. One repeats words like "selfish" and the other uses jargon and multi-syllabic words. I guess Megan thinks that this disguises her strawman argument. I'm glad we can all agree that we are in favor of some but not too much regulation.
Back in the real word, the only cripplings of the bank system in a century occurred before and after Glass-Steagall.
"We'd be less likely to see universal health care, less likely to fix our immigration problems (one way or another), we'd see damage to worker's rights, and poverty and income inequality would get worse, not better."
Freddie,
If you are concerned about inequality, you'd actually have less of it if the worst happened. Prosperity increases inequality, because when the economy does well, the rich tend to do even better. Compare the inequality levels between, say, the late 1970s and the late 1990s.
I'm a registered Democrat, but also a former business exec, and I think this post is pretty much dead on. Having experienced poorly designed, highly reactionary legislation like Sarbanes-Oxley first hand, I fear the potential for really counterproductive regulation at least as much as Megan does.
One thing I'd observe, though. One would think that the ideal regulatory solution would be an independent agency, staffed with economic and finance experts, and given a broad charter to regulate systemic risk as it sees fit. Something like, say, the Fed. Hmm, come to think of it, wasn't the Fed chartered to regulate lending standards? Given broad discretion to balance growth with various inflationary pressures (including bubbles, if they saw fit)? Wasn't their chair the most credible economic spokesperson in the U.S. when he repeatedly dismissed the idea of regulating derivatives?
Perhaps, if the Fed had a more well-designed oversight or advice mechanism, it might have tackled some of these things early enough to have given us a bumpy ride down a steep hill, instead of a fall from the cliff. But what would that oversight mechanism look like? And would anything really have been powerful enough to face down the mystique of Greenspan, and the market fundamentalism he espoused?
The point is, any mechanism you come up with is inevitably influenced by politics and ideology, to the detriment of either effectiveness or efficiency or both. We're just going to have to accept that a sub-optimal, bureaucratic solution is the best we're going to get. It's still better than the magical thinking about risk management exposed by this crisis.
I will admit to occasionally wishing Ms. McArdle would post more frequently. Then she puts up something like this and I regret ever having that wish. Very, very nice.
Unfortunately, Ms. McArdle, the erudition required to understand your argument means that it cannot be debated publicly amongst those in a position to make such arguments. Systemic and local risk? Multiple equilibria? Heck, even getting the plural form of equilibrium correct is beyond even most of our "high-brow" media.
Then again, I'm one of those coastal elites who made the unfortunate decision to believe that the things I studied in school actually described reality. Who needs all that, when you can get "starbursts" from a an inappropriate wink?
I do agree with your argument. However, I do worry that those who would actually be capable of implementing such a regime would profit much more handsomely from subverting it. To me, this is the real problem.
One final rant: the singular of alumni is alumnus, not alum.
Freddie, you make a total collapse sound much more appealing than it really is.
"One final rant: the singular of alumni is alumnus, not alum."
"Alumnus" is the male singular of "alumni" (the female singular is "alumna"). So "alum" is probably Megan's way to make the singular gender-neutral.
Yeah, but Rob, think of the children.
Forget every type of regulation but one. The Feds regulation of it's member banks. What we have is a banking crisis. The Fed through rules and regulation of member banks is supposed to insure the quality and quantity of bank assets. (admittedly the investment banks were under the SEC) The banking system is collapsing. Put two and two together. The Fed failed,on a massive scale.
The banking crisis in the Great Depression was an effect. Note the wave of bank failures came more than two years after the stock market crash. The banking crisis in this case is the cause.
We are not going to need a lot of new regulation for a long time. Perhaps a generation. People are no longer going to entrust their money to the geeks grifters and pigmen who call themselves bankers or investment advisers unless they are given excellent reasons to trust them. Every single expert is being proven wrong spectaculary on a daily basis, and that will continue to be untill the time comes that they will be universally seen as parhias. Until like in the Great Depression Wall Street bankers or stock brokers were held in broad contempt.
That is how this cycle will end.
Yeah, but Rob, think of the children.
What about them? They'll get to hold it over the heads of their children and grandchildren, and that's compensation enough. Why in my day, my whole family had to share cell phone minutes, because they stopped making them after The Crash!
Shorter Freddie @ 7:16 PM: "Wall Street Collapses; Poor and Minorities Hardest Hit"
I kid, I kid!
For the posters who seem to hate free markets, bankers, etc. well God bless you, but you must live in a never never land.
Milton Friedman would always say that he was in favor of competition, not business interests. Regulatory agencies are anti-competitive, creating political markets to allocate resources. That worked well for Stalin, Mao and others didn't it.
How did the government regulation of Fannie do? With two hundred employees assigned to nothing but regulating it, why did they fail to see anything wrong. Or were they no match for the political desires of Franks, Dodd, and Maxine? Did these people care about the solvency of Fannie? The record clearly shows that it was not a priority. But draining the resources to fulfill a social agenda, that they made sure of.
So we can look forward to government regulated monopolies with large dead weight losses for society.
And people who hate those high paid types on Wall Street will be happy as those jobs leave the country. Why shouldn't China, India, Ireland, etc. countries that are increasingly free market after learning that excessive government controls don't work.
I too favor the second approach. But I feel compelled to point out that the kinds of pure speculation I engage in professionally really are a net social benefit of zero at best. And that's the optimistic case, where my firm doesn't contribute to systemic risk. It's hard for me to see how even very punitive restrictions on hedge fund trading could generate much deadweight loss at all.
Maybe everyone else is adding value, I don't know.
Two, Maybe Even Three, Senses Of Regulation
Sebastian Mallaby says the following:
http://www.washingtonpost.com/wp-dyn/content/article/2008/10/05/AR2008100501253.html?hpid=opinionsbox1
"The financial turmoil has pushed the Obama campaign into the lead, and this is mostly justified. Barack Obama is more thoughtful on the economy than his opponent, and his bench of advisers is superior. But there's a troubling side to the Democratic advance. The claim that the financial crisis reflects Bush-McCain deregulation is not only nonsense. It is the sort of nonsense that could matter. "
You should read the rest of the column to understand why he says that.
I want to make a point about regulation. On the one hand, regulation can be seen as inhibiting the free market, keeping businesses from doing things that would enhance the economy. On the other, regulation can be seen as forcing more conservative business practices on the free market, in order to enhance the economy.
I see regulation through the eyes of taxpayers who are the ultimate guarantors of our financial system in a crisis. If the taxpayers are going to have to foot the bill in the end when crises like this one occur, then I think that it is entirely appropriate that taxpayers put constraints on businesses and business practices in order to guarantee that business in this country in some areas is conducted in a more conservative manner.
So, if you don't want the government to be the ultimate guarantor, then I can see arguing against regulation, since the losses will be borne by businesses. But if not, then government can put in place constraints on what is really their investment.
I agree with Mallaby that it is a real concern that the reaction to this crisis, as in all crises, will be over-regulation. I do not agree that the reaction should be no regulation, but rather minimal and effective regulation to obviate the occurrence of crises.
There is also a lot of talk about socialism, etc., but that is a lot of nonsense. We will continue to have a free market and pursue free trade, however imperfectly. In the real world that is all that we can expect.
To rapier
Bank failures did help start the great depression.
The failure today is a failure of management. Financial firms let employees become extremely rich, extremely quickly, while playing with other people's money. And on the downside, you get fired and try it again with a different employer. What do you expect to happen?
Good regulation, bad regulation, crazy Fed, sane Fed, the mangers and owners of these firms failed to do their job.
And why did a sort of black market in credit swaps occur. Normally you see black markets with willing partners created when governments seek to control such transactions
Moreover, it seems to me that at least some of the people who are tremendously excited about the prospect of regulation are not excited because they are worried about the health of the financial system so much as they are intoxicated by the power that greater regulatory authority might give a liberal government to advance other goals, such as redirecting capital flows to more "deserving" uses, or reducing income inequality. To the extent that you wish to reduce income inequality, there are much better ways to do it than crippling your banking system so that bankers can't get rich. And the aggregate record of governments at directing capital flows in welfare-enhancing ways is, to put it mildly, abysmal.
1. Income inequality is among the causes of the credit crisis. Stagnant wages and rising health and education costs led the median household to raise its level of indebtedness in order to maintain consumption by using homes as piggybanks. In a world where median incomes had grown as the economy grew over the past 8 years, the real-estate bubble might not have led to a credit crisis, because households would not have been so heavily leveraged. Income would have flowed not into record corporate profits (especially financial company profits) which needed to be invested and created pressure for risky loans, but directly into consumers' pockets.
2. What makes liberals happy is that you are not actually allowed to put scare-quotes around "deserving" anymore. We have been saying for decades that it is better for the country and for the economy to spend money on infrastructure and education than to hand it back to people, mostly rich people, and let them spend it however they want to. We were right.
3. What do you mean when you say the record of government in redirecting capital flows is "abysmal"? All government spending consists of redirecting capital flows. Social Security, Medicare and Medicaid, and the federal highway system have all accomplished their goals quite effectively. The Earned Income Tax Credit does quite nicely too.
My sense is that liberals are mainly glad because, as Jeffrey Sachs puts it, this is the end of the Reagan era. And that's true in so many ways I can't really enumerate them here.
any liberals cheering the full extent of this crisis, and not just the chance for us to pin back the ears of overindulged bankers and banks, are fools. - Freddie
Not to mention figments of someone's imagination.
True, capitalism is simply an economic system, unlike socialism, which organizes an economy around a specific political philosophy. BUT there are some very attractive freedom-enhancing requirements of capitalism, such as private property, which cause it to be associated with certain political ideologies, many of which I am very fond. And the fact there has never been a socialist democracy shows that capitalism and political liberties can be empirically associated. So yeah, capitalism itself isn't ideological but it usually brings some good stuff along with it. Assuming you value freedom over equality.
What is extremely telling here is that, once again, anyone who disagrees with 'conservative' economic policy is a 'liberal'.
Uh, no we're not. We're for the most part reality-oriented moderates. And we were right, dead right about what would happen in the absence of regulation and an administration that winked at any transgressions on the part of businesses. Oddly enough, most 'liberals' like capitalism just fine. We just think that history has shown us what happens in the absence of regulation and a skewed tax policy. So we don't think, out of the blue, that regulation on food and water quality would be a fine thing 'just because'. It was because clear and egregious abuses occurred in the absence of regulation. We don't think financial institutions should be regulated 'just because' or because we're 'jealous of the Captalist's Freedoms'. We think they should be regulated because history has shown us what happens when they aren't. Iow, pragmatism vs theory. And, as a lot of people seem all too willing to admit - now - there were problems with the theory. Of course, rather than say that theorizing is a poor guide to real-world policy, it seems that the assumption is that the old theories will be replaced with better ones, slightly tweaked.
And this time it will be different :-(
"Capitalism has no ideology, it just has the profit motive"
Nonsense! Capitalism is based on private property, competition and freedom of choice. Socialism, communism and other types of authoritarianism believe in the government dictating outcomes, while capitalism argues that the government should set the rules of the game and then 'let the best man win'. Zero regulation isn't free markets or capitalism, it's anarchy.
Capitalism is exhausting because, to keep making big money, one has to continue to contribute, continue to create value, continue to outperform the competition. Granted, the system isn't perfect and some simply get lucky, but overall, the only sure way to come out on top is to continue to beat the competition, and that's hard. It's no wonder that successful businesspeople that make it to the top sometimes want to change the game so that they can stay up there more easily.
The ideology of capitalism is well represented by DanC's quote of Milton Friedman - that he was in favor of competition, not business interests.
As libertarians go, I'm...
Are you still labeling yourself a libertarian? That's adorable!
"We have been saying for decades that it is better for the country and for the economy to spend money on infrastructure and education than to hand it back to people, mostly rich people, and let them spend it however they want to."
What exactly do you mean by "hand it back to people"? The money is theirs, not yours. You can argue that more should be confiscated from rich people to pay for infrastructure and education, and I might agree. I'm happy to contribute to the government, but the money is mine to begin with.
Another way to look at the basic ideology behind capitalism is anti-slavery - I don't belong to the government, and every last dollar of value that I create does not belong to the government. Thus, every dollar that the government fails to confiscate is not a dollar that the government handed to me.
Ann, I promise you, if they could make living in communes grow the GDP and increase corporate profits, the i-bankers would be pushing all of us into ahsrams.
You have linked a certain vision of America to your vision of capitalism. But that's nonsense. It's comforting for those of you who uncritically think that conservatism and capitalism are natural allies. But capitalism is inherently anti-conservative, which is why social conservatives (like yourself) are going to increasingly find themselves in a country that they don't recognize.
Freddie gets it. As Marx put it:
Constant revolutionizing of production, uninterrupted disturbance of all social conditions, everlasting uncertainty and agitation distinguish the bourgeois epoch from all earlier ones ... All that is solid melts into air, all that is holy is profaned, and man is at last compelled to face with sober senses, his real conditions of life, and his relations with his kind.
I'm not going to try to make a full defense of Marxism here... it won't fly. Let's just say that I've seen the Friedmanesque and other standard arguments before, and most of you have probably seen the responses to them. I view that state as inseparable from capitalism, and do not think that the translation of all social relations to the market is the same as freedom. The question is, can we still have interesting conversations given the distance in viewpoints?
Freddie -
Investment bankers are salesmen (very good, polished, bright ones) and yes, they'll market whatever they think will sell. But why do you talk about increasing corporate profits or growing GDP? Investment bankers are looking for ways to make money for themselves, not ways to grow GDP. And what does that have to do with any of this?
The challenge for capitalism is to not get co-opted by any one group, either unions or politicians or businesspeople or populists. It's not easy, but what is?
Lemmy -
You say that you "do not think that the translation of all social relations to the market is the same as freedom."
What do you view as freedom? Is your idea of freedom government forcing others to do what you think that they should do? The difference is between choice and coercion, since under capitalism people are free to form communes, free to give to others (which is quite common in the US), free to submit to a 'central' planner, free to do any of the things that they might also do under communism. The only difference is that under capitalism, you have to persuade, rather than force, others to go along.
Most of you astound me.
You're so certain in your assertions and so forceful in your arguments. You're also blissfully ignorant to the true nature of what you propose. You're blinded by emotion and rage because the box in which you've grown accustomed to living is slowly falling apart in front of you. Therefore, you lash out in anger and demand retribution and protection.
In exchange, you're willing to not only give your own bodies and minds over to slavery, but to demand that everyone else do so as well. And you further claim it's for our own good.
You would willingly damn your children to a lifetime of degradation - beholden to the debt you're creating - in a vain attempt to rescue your 401K, prop up the value of your house, or justify some political viewpoint all while claiming that those of us who don't want to play along must surely be mentally ill or just plain stupid.
The saying goes "...people get the government they deserve..."
If you all represent a good cross-section of the "people" in this sense, and judging by what I read and hear all around me every day - you do, then we're all about to get just that.
In spades.
"Stagnant wages and rising health and education costs led the median household to raise its level of indebtedness in order to maintain consumption by using homes as piggybanks."
Brooksfoe,
Do you think government involvement in the financing of health care (via Medicaid and Medicare), education (via Sallie Mae, subsidized loans and grants), and housing (via the GSEs, the mortgage interest tax deduction, etc.) might help explain the rising costs of education, health care, and housing (up until the housing bust, that is)? Might it make sense to consider the unintended effects of some of these government policies and then consider some different approaches?
And we were right, dead right about what would happen in the absence of regulation
isn't it interesting that hedge funds are performing less poorly than just about everything else? how regulated are hedge funds? not very? hmmm....
the financial markets in general are regulated. i mean, there are regulatory agencies, and, you know, rules and stuff. the fact is that both regulators and regulatees botched the pricing of risk.
i also find it interesting that multiple people (new york times, john mccain, and another person whose name escapes me at the moment) were sounding warnings about fannie mae and freddy mac years ago. yet the financial geniuses in congress resolutely ignored every bit of evidence.
liberals point to that great meanie george bush and bellow 'deregulation sucks'. conservatives point to chris dodd, barney frank, et al and holler 'social engineering sucks'.
in this particular case, i think the conservatives have the better argument, but a pox on both their houses.
Bring on the Five Year Plans and let their sequential failures begin.
"Obama is more thoughtful about the economy."
What exactly does that mean? Are his nipples more sensitive than McCains? Seriously, when political gibberish is reduced to a constant flow of platitudes, the word thoughtful is completely debased.
Good comments though. Much more interesting and enlightening than Megan's little narrative.
Alan Gunn wrote;
"Assuming that business people are free-market ideologues is just wrong."
Correct, and a necessary reminder, but also subject to misinterpretation. Some businesses want regulations and subsidies, obviously those who are large and entrenched in their markets and thus will gain by regulatory barriers to entry. Whilst using, say, GM as their strawman, they forget about Joe The Plumber. In our zeal to apprehend CEOs for their ritual public floggings, we need to keep in mind that when the show's over and the mob shuffles home, there's still a long line of Joes who "qualify" for the same punishments, at far less pay per stroke.
In other words, in the politico-economic sphere, we need to segment the "market" to understand it. There's large and entrenched, large and new, small and entrenched, small and new, etc etc. Different states, different motivations, different outcomes.
odograph writes;
"Too many forgot that our American success came from a moderate, regulated, market economy."
This statement ignores the remarkable economic progress in America from the early 18th century through WWI.
Regulations have had both positive effects and negative. At their best, they promote competition and thus float all boats. At their worst, they turn recessions into depressions. The meme "regulation is good", I fear, leads to the mindset that any and all regulations are good, causing folks to neglect due diligence when considering new or renewed regulations.
Don the l-D wrote;
"I see regulation through the eyes of taxpayers who are the ultimate guarantors of our financial system in a crisis. If the taxpayers are going to have to foot the bill in the end when crises like this one occur, then I think that it is entirely appropriate that taxpayers put constraints on businesses and business practices in order to guarantee that business in this country in some areas is conducted in a more conservative manner."
The problem is that all taxpayers will foot the bill, but not all businesses received a bailout or conducted themselves in such a way as to necessitate a regulatory overhaul. Why should my credit union, or auto mechanic, have to bear higher taxes and regulation because of the actions of [b]some[/b] investment bankers, politicians, and regulators?
I have no problem with the federal government attaching strings to bailout packages handed to specific banks, whether for toxic security buys, preferred stock purchases, or short-term loans for working capital. But why the rush to also punish those many more firms who acted and continue to act sanely and responsibly?
brooksfoe wrote;
"1. Income inequality is among the causes of the credit crisis. Stagnant wages and rising health and education costs led the median household to raise its level of indebtedness in order to maintain consumption by using homes as piggybanks. "
Median households were not forced to buy houses, much less at prices well above the usual 2.5 to 3 times gross annual income. They certainly weren't forced to contract themselves into ARMs and balloon mortgages. Regardless of what the politicians and activists and mortgage brokers had them believing, folks in my region who make $50,000 gross cannot afford a $300k house in the long run.
Nobody forced people to take on a 2nd mortgage to pay for that SUV, either.
Culturally we created a disconnect between actual income and lifestyle expectations. Income inequality "caused" that in the same way that income inequality "causes" some folks to take up drug smuggling. Most folks who got themselves into financial trouble did so not because of needs but because of wants.
ScentOfViolets wrote;
"Uh, no we're not. We're for the most part reality-oriented moderates. And we were right, dead right about what would happen in the absence of regulation and an administration that winked at any transgressions on the part of businesses."
Its been quite well established that efforts to improve regulation of Fannie Mae and Freddie Mac came from Republicans, to wit;
http://www.usnews.com/blogs/barone/2008/10/6/democrats-were-wrong-on-fannie-mae-and-freddie-mac.html
Also, the securitization of mortgages began back in Clinton's 2nd term. Why is none of the current mess his fault?
Former President Bill Clinton: "I think the responsibility that the Democrats have may rest more in resisting any efforts by Republicans in the Congress, or by me when I was President, to put some standards and tighten up a little on Fannie Mae and Freddie Mac." (ABC's "Good Morning America," 9/25/08)
We won't be able to fix any problems until we start from an honest assessment of how things actually happened. Parroting the DNC's talking points is only going to ensure that work on overhauling the regulatory system begins from an erroneous initial state.
To all who type that Capitalism has no ideology...In fact is does, but not read by many...The Philosophy of Objectivism...used by Industrial Capitalists that know of the philosophy. Start with "For the New Intellectual", on the web read "The Intellectual Activist" and The Ojectivist Standard" follows a sample of the philosophy...Reasoning is one's ability to identify and integrate, without contradiction, the materiel provided by the senses, and consists of Cognition and Evaluation. Cognition is one's attempt to discover what things are, their Nature, Attributes, and Properties. Evaluation is one's attempt to establish the relationship of things to one's self...good for you, bad for you, to be sought or avoided. Boorey Pith
The only failure of "regulation" in this financial crisis is the failure of Rep. Barney Frank (D, MA, Chairman of the Financial Affairs Committee) and Sen. Christopher Dodd (D. CT, Chairman of the Senate Banking, Housing, and Urban Affairs Committee), supported by most of Congress, to regulate their own desire to buy votes with easy mortgages.
The financial markets did just what most of Congress wanted. They lent money to Fannie Mae and Freddie Mac (off budget) so that FanFred could do the bidding of Congress.
Congress is now saying "Yes, FanFred offered to buy up those risky loans, but you mortgage lenders should have had restraint and not made them so risky. How could you expect FanFred (or us) to look at the loans we were buying to see if they were good? You are greedy, bad men."
The Government removed Fannie Mae and Freddie Mac from market discipline by guaranteeing it implicitly as its own creation, then told it what to do through legislation, pressure, and its own special regulator OFHEO. Fan and Fred were staffed with government elite.
How could two companies ruin the US and the worlds financial markets? With the power and credit to buy up 90% of all prime mortgages and 20% of all subprime. Fannie and Freddie together guaranteed $5.4 trillion of housing debt (that is $5,400 billion, or $5,400 thousand million). Compare that to the previous $5.5 trillion budget debt of the US.
The market value of subprime loans fell in half when Fannie and Freddie collapsed and could not support that market with its increasing borrowing and purchases. That caused massive losses for institutions worldwide holding the other 80% of subprime mortgage bonds.
Congress ran Fannie Mae and Freddie Mac into the ground, plucking presents along the way. Congress set up Fannie and Freddie, took full responsibility by effectively (but unofficially) guaranteeing repayment of its debts, removed it from private market discipline, funded it through massive private borrowing outside of Government budget accounts, commanded it to do risky business below usual standards, restricted its regulation to a special office set up by Congress (OFHEO), and then ignored that regulator.
Any opposition came from some Republicans and the Bush administration, who were ineffective.
Blaming Bush is misguided; blaming the free market blames something that was not allowed to operate. Blame the corruption of Congress, mostly the Democrats. They assumed oversight of a huge off-budget operation to grant risky loans, and ignored all corruption and warnings.
This is a failure of IN PLACE regulation, actively suppressed by congressional committees who looked the other way, because it was in their political interest for Fannie and Freddie to do just what they were doing. Their motto was "So far, so good".
"I view it as an attempt to make our institutions more effectively channel self-interest into collectively welfare-enhancing activity. "
I'm reading Hayek now and he would probably agree with you. The Rule of Law (or call it regulation) should establish a broad framework for, as you say, transparency and most importantly predictability. Who can be surprised at the market turmoil when the feds are strong arming a new group of capitalists every day with a new scheme they thought up the night before? There are simply too many variables in a free market to allow any human to "regulate" them effectively.
The feds would do more good to force banks and corporations to open up their books to a lender when they need to borrow money than to recapitalize a crooked or stupid operation. Have Dodd and Frank resign. Investigate the Three Amigos (Raines, Johnson, Gorelick) under existing statutes. Then, get out of the way and let the markets grow.
Consider what is happening today:
The central banks the world over are pumping money into banks like never before seen in history, and banks don't want to lend to any but the more credit worthy borrowers while these governments, and many of the commenters I see online that agitate for more and more regulation, pilloring the banks for not opening up the spigots to reinflate the credit bubble!
Greater regulation of lending/borrowing standards is a policy that is in direct opposition to the goal of greater credit inflation- the very policy being explicitly pursued by every government in the developed and developing world.
Those that can't see this fundamental contradiction are doomed to suffer for their stupidity, as they probably deserve.
Again a very interesting comment thread, unfortunately peppered by movement conservatives who are about to have their hats handed to them by the American public.
Andrew Garland, you do realize that Barney Frank and Christopher Dodd have been the Chairmen of their respective committees for two years.
Just what the hell were your beloved Republicans doing prior to that?
I see regulation through the eyes of taxpayers who are the ultimate guarantors of our financial system in a crisis. If the taxpayers are going to have to foot the bill in the end when crises like this one occur, then I think that it is entirely appropriate that taxpayers put constraints on businesses and business practices in order to guarantee that business in this country in some areas is conducted in a more conservative manner.
I fully agree with this. I would prefer that regulation be limited to enforcing transparency and players own their losses. But (for good or ill), that's not in the cards. The losses get big enough - systemic enough - there becomes a clamor to "do something" and me and my kids get stuck with the bill.
So how do you regulate away "too big to fail"? That's what I'd like to see come out of this. I don't claim to understand accounting, but why can't you get rid of all of the off balance sheet nonsense, and regulate total liabilities? When any one player gets too large (25% of a given market - interpreted liberally), they get broken up.
Along with that would be an explicit policy that losses will not be socialized. I don't know if government would keep that promise in truly bad times, but better that message than the wink-wink, nudge-nudge that Freddie and Fannie were able to give.
As I said, I don't understand accounting, and I've probably made a hash of the details, but could something like this be made to work? Enforce transparency and competition, and keep any player from being able to knock down the whole system.
Thanks for telling me which way of thinking about regulation you support. I would have never known due to the carefully neutral presentation of the perceived choices.
People who focus entirely on the last 8 years, or even 16 years, when discussing the problems with Freddie and Fannie are ignorant. Fannie and Freddie were nearly guaranteed to become debacles some day, because all the incentives were put in place, decades ago, to make them so. You shouldn't pretend, as some extremely ignorant people do, that an entity which can sell paper with an implied government guarantee, allowing the entity to borrow money at below market rates, is a private entity. You shouldn't pretend that such an entity, when instructed by Congress to expand rates of homeownership, and allowed to pay it's management enormous bonuses for doing so, will not eventually engage in extremely risky practices.
That some extraordinarily ignorant people now state that it was FAILURE of the state to regulate that led us to our current discontent, rather than the state's MALREGULATION over many, many, years, is utterly predictable, given that so many extraordinarily ignorant people also continue to believe that the debacle of the 1930s was not also primarily a case of malregulation.
Of course, Fannie and Freddie are also just part of a more broad long term trend in which the state has encouraged debt, as opposed to savings, for many, many, decades. Look no further than our idiotic tax code. Yeah, sure, what led to our current state is that the 535 hacks who meet in the building with the big dome near the Potomoc just have been too inactive. Really.
Experience suggests that financial regulation is actually like a Martindale game, namely, you can decrease the likelyhood of failure but only by increasing the cost of failure. If the cost increases proportionally more than the likelyhood go down, reducing the likelyhood is a bad idea. There are even "cost thresholds" that we can't afford even if we can get to them by significantly reducing risk.
The conclusion is that we're probably better off with fairly common small failures than we are with the occasional big failures that we're seeing.
And then there's the point that much of the regulation that has been tried and proposed didn't actually reduce the odds of failure but did increase costs, both between failures and of failures. That's just dumb.
I come at this from the position of a physicist. If you have an oscillator ( the physicists term for something that moves back and forth in cycles like a pendulum ) you will get the most peak performance by removing any damping ( friction which slows things down ) from the system.
With absolutely no friction you get the highest peak performance from the oscillator. You get the highest highs, but you also get the lowest lows.
The trick is to place just enough damping on the oscillator so it performs well, but avoids the disastrous troughs. This is what the government should aim for.
Interesting thoughts on regulation of banking system. You say: "But this approach sets up a direct tradeoff between growth and safety; in order to get more safety, we give up a lot of financial activity which ultimately reduces the supply of capital." What we actually get is the appearance of safety and actual unintended consequences. Unfortunately, no one or group is sufficiently intelligent to identify let alone fix the consequences of regulatory action. The common result has been that more regulation begets more regulation in the vane attempt to fix the errors of previous regulation under the mantra that we were under regulated.
Fannie and Freddie, two highly regulated GSEs', requires more regulation when the folks in charge regulated them to create the disaster we now face?
Will
You're getting at the essential problem: "regulation" means different things to different audiences.
To libertarians, regulation should enforce transparency and punish fraud.
Rightward types would add damping mechanisms so that innovation creates not too much disruption and the judgment of more venerable entities is given more weight.
Leftward types want to substitute political judgment for market judgment and have a hand in determining purpose, outcome and allocation of gains.
There's wisdom in only one of these approaches.
The CDS (Credit Default Swap) market is the poster child for capitalist greed and gaming the system that currently privatizes profits and socializes losses. By the accounts of those who participate, they wrote swaps with notional value in the quadrillions over the past 3 years. Buffet called these "financial weapons of mass destruction." We've only seen the tip of the iceberg on these instruments.
There were some very greedy folks who sold swaps on Lehman with the assumption it was "free money," because the government would come to the rescue. They didn't remotely have enough capital to pay the "claims" on defaults. It would be like allowing a life insurance company to collect $1 trillion in premiums on a single life with $1 billion in reserves. The irony is thick. A "financial innovation" designed to reduce risk encouraged the riskiest behavior in the history of financial markets.
Re: Also, the securitization of mortgages began back in Clinton's 2nd term.
No-- Ronald Reagan's 2nd term.
"Re: Also, the securitization of mortgages began back in Clinton's 2nd term.
No-- Ronald Reagan's 2nd term."
I thought that the first mortgage securitization was by Ginnie Mae in 1970. One more thing we can pin on Nixon!
But I think JonF's point is that they really took off after tax changes in 1986.
"There were some very greedy folks who sold swaps on Lehman with the assumption it was "free money," because the government would come to the rescue. They didn't remotely have enough capital to pay the "claims" on defaults."
C Brown - where are you getting this? I believe that the final settlement on Lehman CDS's will be next week, but the forecasts now are that everyone should be able to pay, since most of the positions were hedged and thus the net amount was much lower than people feared. In fact, if the true situation had been known from the beginning, a lot of the panic might have been avoided.
Hmmm... If there was government regulation that libertarians could live with, why are we only hearing about now? Perhaps if libertarians had been all along more forceful in their argument for regulation of the second kind, we'd all be better off now.
Too little too late. Now you don't get to complain if society overreacts. Should have thought of that 20 years ago. But instead, libertarians fed us a continuous stream of propoganda and ideology.
Sorry if I sound bitter. Its just hard to be lectured by a representative of the ideology that contributed so much to this present mess.
Kudos to the Economist for bringing together the most distinguished speakers to date for the Financial Crisis: It Would Be a Mistake to Regulate the Financial System Heavily After the Crisis debate! Although commenting on the statements of the two Nobel laureates is a challenging task that may presuppose a lack of even rudimentary humility, this is a rare opportunity not only to read their opinions of the pressing issues of the day, but also to flatter oneself by participating in such a remarkable debate.
The Opposition, Dr. J. Stiglitz of Columbia University, opens with the statement predicting another crisis in the absence of an adequate regulatory system. Yet, in the following sentence the Opposition admits that the “good governance” societies have not escaped the same fate as the “bad” ones. That is to say that, even if increased regulatory requirements equaled better governance, they would not necessarily prevent the next economic/financial crisis or reduce its severity. Towards the end of its opening statement, the Opposition also states that we have a great need of the right regulations and a regulatory system that enforces the regulations we have. It is hard to argue that the new regulations will reduce the severity of the next crisis, if the existing regulations remain poorly enforced. Society often perceives introduction of new regulations on top of the existing but poorly enforced rules with the same attitude – they erode respect for the law.
The Opposition cites the Fed and other regulators for not using all of the tools at their disposal to prevent the excesses that lead to this crisis. Dr. Stiglitz writes “this is the not surprising consequence of appointing as regulators people who don’t believe in regulation.” While I strongly believe that Dr. Stiglitz would be a much more proactive, vigorous, and efficient regulator, if he were in charge of the existing regulating structures, I do not believe that hypothetical new regulatory structures proposed by the Opposition would alleviate the problem at all in the presence of similarly inefficient existing regulatory bodies. I am much more inclined to agree with the Proposition’s unhappy conclusion that historically “new regulations have supplanted old regulations to no avail.”
The theme of enforcing existing regulations is strongly echoed in the statement by the Proposition, Dr. M. Scholes of Stanford University, that “the simple remedy … is to require banks to have less leverage.” While the featured participant Barry L. Ritholtz of FusionIQ quotes the debt-to-net capital ratio of 12 as an example of reasonable capitalization in 2004, by the end of 2007 many banks had seen this number grow over 20, 30, or 40, even up to 48! The reduction in leverage is by far the easiest measure to implement and to monitor. The laws about capitalization/leverage already exist and the numbers are monitored by governments and markets alike. This is also the least costly measure, as it does not by itself require either tax payer funds or new government entities – the two most likely types of rash government reactions to the latest crisis. The Proposition made it clear that the only cost will be born by the existing equity investors, who will see their return on capital go down.
Another line of reasoning addressed by both speakers is a trade-off between innovation and lack of stability. The Opposition claims that ad hoc government interventions are too costly for the society, while the Proposition’s opinion is that these costs are far outweighed by the decades of wealth creation brought by financial innovation and deregulation. A third party opinion and a reference to empirical evidence would be valuable to arbitrate these views. Luigi Zingales of the University of Chicago, with a variety of collaborators, has shown in Financial Dependence and Growth and other papers, including The Cost of Bank Regulations, that more developed financial markets assist in disproportionately faster development of certain industries and, in general, access to better capital markets results in faster growth and higher regulation reduces access to credit. Personally, these papers cannot lead me to any conclusion other than adding new regulations at the time of the credit crisis and slower-to-negative growth will only exacerbate the effects of the current crisis more and possibly will make the next crisis happen sooner rather than later. Not surprisingly, the Economist Free Exchange blog referenced Luigi Zingales on the subject of debt-for-equity swap as an alternative to bailout.
Finally, on a topic not directly covered in the opening statements… Any American regulation would have to go to the U.S. Congress. This is not a very encouraging thought. The soon to be replaced U.S. President has one of the lowest approval ratings in the U.S. history. Yet, the Congress trails him in this regard. Even the urgent $700 billion “rescue” package laden with extras was used to advance petty interests showing disregard to the interests and opinion of the public. Expecting the legislative branch to create a meaningful set of rules to correct the past problems and to address the future ones may be too much of a pipe dream. Instead of the government trying to regulate what future innovative products may become available, I would rather see a uniquely gifted passionate economist and believer in regulation like Dr. Stiglitz enforcing existing rules while in charge of current regulatory bodies, just like he was at the World Bank, or see equally gifted and equally passionate Dr. Scholes’ explain to the government how not to hinder financial innovation.
"As libertarians go, I'm relatively in favor of financial regulation."
Or, "As libertarians go, I'm not one."
"And we were right, dead right about what would happen in the absence of regulation..."
In one of the most heavily regulated industries in the country??!!
As soon as a massive regulatory system fails (as they always do), these schmucks start whigeing about an "absence of regulation.