The "sophisticated" banking systems and capital markets that we're always flogging to developing countries are like nuclear reactors of the Chernobyl design. Sure, they are very powerful, very sexy. When they work they can light up whole cities, and that's gotta be attractive if you're sitting in the dark. But they have deep weaknesses, structural flaws, inconsistencies that are resolved only with generous applications of duct tape. Everything seems to work most of the time, but they are an accident waiting to happen. When an accident does happen, there is a story, perhaps a true story, about the particular screw-ups that were proximate cause. But focusing on those misses the point. We ought to get the engineering right before trying to operate the plant.
Financial systems are much more massive enterprises than nuclear power plants, and much more important. We need to redesign our financial system not only to be more robust, but to be more effective. Lost in the flamboyant pain of the current crisis is a quieter tragedy. We have misallocated natural and human resources on a vast scale over the past few years, and it won't have been the first time. The real economic meaning of financial losses in the housing sector is that hands and minds were squandered bulding houses when they should have done much better things. Timber was felled and oil wells pumped dry, and what we made turned out to be of less value than what we destroyed. We could have predicted and avoided that. A reasonable financial system would have predicted and avoided that.
Treasury Secretary Henry Paulson has mooted a variety of reforms in response to the present financial crisis. Reading through, those proposals amount to a rationalization of the hodge-podge institutions that regulate financial markets. That's not unwelcome, but it's not what's needed. It's like responding to the Chernobyl meltdown by issuing three-ringed binders filled with better procedures about how to manage the plant. Regulation can compensate for minor flaws. But it can't overcome a design that is structurally unsound. Our financial architecture is structurally unsound, so our task is not to rationalize the regulatory regime, but the financial system itself.
That will require changes far more challenging to incumbent firms than what Mr. Paulson proposes. Institutions that are too big to fail and/or capable of moving market prices unilaterally don't sit well with the theory of financial markets. Financial firms can be regulated utilities that handle essential plumbing but bear little risk, or they can be aggressive risk-seekers looking to play every angle and milk every opportunity. They cannot be both. The gentlemen at Mr. Paulson's alma mater may not like the implications of that, but the principle is correct regardless, and we ought insist that it not be fudged. The "Nationally Recognized Statistical Rating Organizations", and the constellation of professional norms and judicial safe-harbors that link their opinions to the behavior of institutional money are an abomination, a legal discouragement of the independence of judgment upon which accurate prices and market stability are based. Their special status simply has to go the way of the dodo. This has to go a lot farther than merging the SEC and the CFTC. Rather than placing our faith in the Fed as an ever-watchful superhero, saving us all when financial catastrophe strikes from outer space, we can and should better manage our affairs here on Earth to avoid those catastrophes in the first place.
These have been great times to be a cynic. But, at long last, appropriate cynicism is finally getting priced into the market. There's not much intellectual alpha left there. When this all washes out, we do want an informationally efficient, market-based financial system. It's time to start talking specifics about what we need to do to get there. Before very long, all options may be on the table. Let's have some good ones ready to go.
This article has 8 comments:
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HilBily
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14 Comments
Mar 31 06:24 AM-
CarlosSlim
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120 Comments
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Mar 31 12:58 PMAll regulations should be "voluntary".
Why...in the entire history of Capitalism, there has never been a single case of a Capitalist doing something that harms individuals or even entire societies.
Because Capitalists always make the "right" choices.
Capitalists would never, ever, ever make the "wrong" choice just to make a few more dollars profit.
The preceding words have been the root philosophy of the -R political party.
The -R "regulators" have been Wolves watching the Chicken co-op.
Why expect anything different now?
These are idealogues, who have already made up their minds--they are right and anyone who disagrees with them is wrong.
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HilBily
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14 Comments
Mar 31 01:51 PM-
Wez
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172 Comments
Mar 31 03:24 PMRealtors.....this is tough, but the huge commissions they make on each transaction is obviously a formula for disaster.
For those who securitize mortgages, they also need some skin in the game of ongoing payments, not upfront commissions.
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Mbuna
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21 Comments
Mar 31 03:53 PMAll of this fancy talk is just that. The only real question is will greed be subject to regulation or not. I think not. "Privatize gains, socialize losses" pretty much sums up the mantra going on in the minds of the current administration. If you just have a gaggle of talking heads on TV selling it, put a fancy enough wrapper on it or have a big enough smokescreen you just might be able to sell it to the public. Make sure that the financial sector lobbyists line the pockets of congress and voila! Financial problem? What Problem? Everything is just fine, business is handled. No there is no real science here. The real objective is keeping the pigs at the trough. You can call it by different names and have different vehicles for delivery but that doesn't change what is going on.
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CarlosSlim
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120 Comments
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Mar 31 04:14 PMInstead of packing 5 regulatory agencies with corrupt cronies, it will only have to pack one agency!
Nor will Investment banks have to deal with various state regulatory agencies.
Dealing with only just one Federal agency is much easier on lobbyiests who just trying to eke out a living--a few hundred billion here, a few hundred billion there--for their special interest clients.
Now, that's...efficiency!
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User 169218
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4 Comments
Mar 31 07:19 PMThat should prompt a response from someone...
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risheard
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1 Comment
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Mar 31 08:10 PM