In the coming weeks and months, Congress will be turning its attention to financial market reform, in hopes of avoiding future financial crises. According to perceived wisdom, the root cause of the 2008 financial crisis was excessive risk-taking, and proper regulation can detect and prevent such excess in the future.
This view is a pipe dream. Most new regulation will do nothing to limit crises because markets will innovate around it. Worse, some regulation being considered by Congress will guarantee bigger and more frequent crises.
Tuesday, October 27, 2009
Financial Market Reform
My thoughts, at Reason.com. The gist:
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11 comments:
Excellent article - but I have one question. It seems to me that in a perfect world we would not need the Fed and the market would set interest rates and the value of the dollar based on supply and demand, but how do you account for imperfections in the markets such as foreign powers using their currency as a 'weapon?'
"some regulation being considered by Congress will guarantee bigger and more frequent crises" ....
such as ?
I'm with you up until the "...repealing all existing financial regulation, since this would signal markets that they, and only they, can truly protect themselves from risk."
That's sounds like handing the keys to your Mercedes over to the 16 year old kid down the block, and telling him he'll reap the consequences if he drives recklessly. He will. But, he's likely to take others with him.
Doesn't a system with no regulation assume rational participants with a mature sense of responsibility for their actions, in a marketplace with sellers who always provide full disclosure - and/or a marketplace that punishes only the deserving?
As a former Montessori teacher, I'm all for 'control of error.' In my estimation though, this means assuring that those controls of error are built in so that people do their learning before they put the entire economy at risk.
I haven't got a chemical test lab in my basement and a research biochemist on staff, so I really want government to stop industry from putting poisons in my air, water and food - I cannot do that independently.
By the same measure, I want government to block the financial sector from issuing toxic financial instruments that are beyond the ken of the people who are being hyped into their purchase.
But doesn't this assume that banks learn the lesson and decide to be careful? I'm not American so I guess you guys know better than me, but if I'm not mistaken banking and financial crises were much more common during the free banking era than during the post-Depression years (until the '80s), right?
What about just requiring any entity that is deemed too big too fail to purchase insurance against that risk. Basically what I envision is the out sourcing of the risk management departments to third parties that have a true interest in properly evaluating, and pricing the risk.
Boring or less risky conduct would have a low premium. High risk - exciting - highly leveraged conduct would have a high premium. If an institution can't get insurance - it would have to be liquidated and broken up.
Further, if we are doing this, perhaps we should take another look at the FDIC and privatize that as well.
I enjoyed your article. I thought it was informing because it offered a perspective that is opposite of the mainstream idea of financial regulation. I am beginning to see your work as a pioneer in modern libertarianism.
I would like to see more of your work on Keynesian economics. Your article in the Wall Street Journal suggesting tax cuts as a form of stimulus is genius. Larry Kudlow and you seem to have promising, concise, and simple ideas.
-Db
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