It’s good to see that the conservatives have added another voice to the financial reform debate. Jonah Goldberg has stepped up, making his argument after Kevin Drum and Jonathan Chait responded to a previous piece. Jonah:
Frankly, I find it mildly disturbing that Kevin would even make that inference. All I was doing was making an abundantly obvious point: that knowledge is cumulative and that people and institutions learn from their mistakes…
Kevin seems to think this reveals some terrible flaw with markets. I think it’s one of the great things about markets. If only government learned its lessons as well. In business, when a bad idea fails, it goes away and the people responsible lose their money…
Perhaps the chief argument over the financial reform bill is about whether it will allow Wall Street firms to pay the price for their mistakes or whether the government will bail them out (again)…
The only (limited) role for government is to decide whether a product is safe. That’s what the debate about financial reform is about: whether these firms can operate safely for the rest of the economy.
A few things, centered around three points:
Self Correction
– The idea that little “self-correction” has occurred in the US financial markets was hit home during the first day of FCIC testimony, especially during the second panel with Michael Mayo, Kyl Bass and Peter J. Solomon. In a variety of ways, they all pointed out we are still vulnerable to the same structural flaws with the financial sector. See also Greg Kaufmann “wait we are still in trouble?” moment after seeing the panel too.
– I would completely contest that the relevant financial knowledge learned by the agents and firms in this crisis is “cumulative” in the sense of being better for the economy. This isn’t a group of scientists trying to get a better explanation of some natural phenomenon. To keep this in economic terms, this crisis has shown a wave of agency problems embedded inside financial institutions. The best phrase for why people were motivated to do the things they do is simple: IBGYBG–I’ll be gone, you’ll be gone.
It’s easy to imagine that the traders and the rest of those selling subprimes and CDOs, if they could do it again, would be even more vicious in ripping the face off their customers. Why wouldn’t they? And given the large concentration and market domination by these firms, it’s not at all clear that their customers are going to be in a position to bring them into line.
– The other obvious market failure is that in a ruthlessly competitive arena that is judged primarily on quantitative measures, any ability to juke your statistics forces others to participate in that as well. We see this in a variety of ways I can describe if people are interested, but if your competition is repo 105ing their balance sheet to make it look like they are getting better returns with less leverage, they are going to get better deals on customers and capital than you are going to get and put you out of business. So you better do that as well. The notion of Milton Friedman-ite self-regulation through reputation effects has been a complete failure.
– I actually wanted to make sure that what the financial system may have learned was centered prominently in the debate, hence why I’m tried to focus on the doom loop theory that the real lesson is, in the absence of regulation, for firms to get bigger and riskier knowing that they will be bailed out.
Learning from Conservatives
– But let’s get specific on what the financial industry has probably learned from the crisis. Let’s jump to National Review, Regrets? TARP, reconsidered., December 22, 2008 (my bold):
LARRY KUDLOW…The TARP plan that debuted in October was described as a way to purchase toxic assets from banks and other lenders in order to unclog the credit system, which is so essential to the efficient functioning of the economy. I supported that plan then, and I still do now….
DONALD LUSKIN….I supported TARP when it was being debated in September, and I still do — all the more so, since it has been transformed primarily into a mechanism for recapitalizing banks (temporarily) rather than buying illiquid assets (permanently). As a conservative and a libertarian, I am repelled by government intervention like this. But we don’t have the luxury to stand on principle.
JIM MANZI…I supported the original bank bailout, and continue to believe that it was a painful, but correct, decision….
ANDREW STUTTAFORD…TARP was the hastily and imperfectly improvised response. While it was not originally structured in the way that I would have preferred…it was better than anything else on offer and I was a supporter. The alternative, doing nothing, might have been intellectually satisfying for some market fundamentalists, but it threatened leaving a wasteland in its wake.
(In the article, most were disturbed that TARP money was going to the auto companies.)
Check out the logic of the bold text. This is what people mean when they say “no bailouts” aren’t credible. It’s important to remember that in the middle of a crisis a GOP-appointed Hank Paulson, GOP-appointed Sheila Bair and GOP-appointed Ben Bernanke, all with the support of a Bush White House-sponsored EESA were forced to bail out the financial system, and leading conservatives and libertarians gave them intellectual cover by saying that not running a bailout is something akin to a “luxury” of appeasing “market fundamentalism.”
I agree, but that double downs the imperative to get regulation right here. It is important to give regulators credible options on what to do in the middle of a crisis. And it is also important to get regulation that reduces the likelihood of a crisis and the impact of what the crisis can do.
One move might be silo out certain lines of business, like those associated with the payment mechanism, FDIC insurance and the Federal Reserve’s discount window from business lines who want to trade with their own money for their profit.
I assume people like Luskin would at least be open to this idea given that he was forced to compromise his principles on the bailout. Here he is, Feb. 8th, 2010, in the Wall Street Journal, Republicans and the Populist Temptation (my bold):
Just 24 hours after Mr. Brown’s upset win, the White House let it be known that a radical plan to break up the largest banks, and to limit their size, was about to be announced. The next day the plan was revealed, and christened “the Volcker rule.” What better way to lure Republicans onto a populist, antibank bandwagon than to associate it with the legendary Reagan-era figure?
So evidently I’m a radical, populist anti-banker for thinking that is a good idea. Huh. So given the general lack of interest in financial regulation, but also the general defense and the carrying out of bailouts, should the financial industry learn that conservatives and Republicans will bail them out and call any attempts to regulate them radical?
(To their credit, Kudlow likes the Dodd Bill, and Jim Manzi is a fan of the general risk-siloing idea of the Volcker Rule approach, which means that in addition to being pompous he’s also a radical populist. Heh.)
Has the Financial System Broken a Window?
So as far as I understand conservatives are often motivated by a theory of “broken windows”, where if you don’t crack down on the little things in a major way ‘disorder’ will increase and more serious crime flourish. Leaving aside the empirical dubiousness of the claim, why aren’t conservatives really cracking down on all the fraud that people are finding? Why don’t they take repo 105 as seriously as a kid selling a joint? If there’s been a conservative rally for serious criminal investigations and prosecutions following the Valukas Report on Lehman’s bankruptcy, I haven’t seen it.
So is it all coddle, all the time?
Rortybomb 
I’m only guessing, but I bet the partisans at NR aren’t the best place to go for anti-(Bush’s)-TARP. That partisans support their side’s policies should shock no one.
Here is Austrian Mike Shedlock calling for Criminal Indicments following the Valukas report:
http://globaleconomicanalysis.blogspot.com/2010/04/geithner-and-ny-fed-accused-of.html
“That is a very damning appraisal of the competence of Ben Bernanke and the entire Fed. It is also grounds for indictment of Tim Geithner and the board of directors at Lehman. Assuming Bernanke was a willing conspirator in the ongoing coverup of Lehman, he should be indicted for criminal fraud as well.”
A few comments come to mind.
1. In the debate about TARP in fall 2008, the promoters of TARP used a forced choice argument: either TARP or nothing (chaos/economic collapse/cannibals in the streets). This was not true then and is not true now. There was always the option of putting the banks through some form of bankruptcy, firing the boards of directors and senior executives who should have been held responsible for the fiasco, and using the Federal Reserve and the FDIC to stabilize the general economy and protect small and medium sized depositors as they were supposedly designed to do, as well as a fiscal stimulus involving direct government purchases (not tax cuts and similar measures that are not likely effective in a liquidity trap).
2. The political problem is clearly bipartisan. TARP was defeated on the first try by a rather unlikely combination of votes from the left of the Democratic party and the right of the Republican party. Similarly, support came from the establishment and center of both parties. The issue really transcends the usual political stereotypes. In reality, the policies are harmful to most people across the political spectrum. Who benefits from a banking cartel? Answer: the banking cartel. Who loses from a banking cartel: just about everyone, the cartel’s customers.
Sincerely,
John
“that knowledge is cumulative and that people and institutions learn from their mistakes…” — Goldberg
The thing is you learn of the problem, but some problems are exceedingly, unrealistically, or impossible to solve if you straitjacket yourself as to the solutions you will consider, like I will not consider any government role because it conflicts with my extremist right ideology.
It’s like knowing the problem of polio but refusing to consider any solution outside of herbs. Learn all you want from your past failure with herbs, but your not going to prevent it, or cure it, with new herbs — you have to be willing to consider modern scientific medicine.
With banking, the pure free market problems are too great to solve well with pure free market methods. Corporate ownership is too diffuse to watch management well. This is why boards are laughably weak, under-resourced and captured (see the outstanding book “Pay without Performance”, by Harvard’s Lucian Bebchuk and Berkeley’s Jesse Fried for more); asymmetric information is just too great, and so are externalities, to name just a few things.
And believe me, the free market has had plenty of time to learn about this. Before serious banking regulation in the 1930s (that the Republicans largely dismantled in their recent era of political dominance), quoting from the text, “Money, Banking, and Financial Markets”, 3rd Edition, by Miller and VanHoose, “In the United States between the 1830s and 1930s, national banking panics seemed to occur in regular cycles of fifteen to twenty years.” (pages 35-36), and this resulted in regular severe recessions and depressions.
“The notion of Milton Friedman-ite self-regulation through reputation effects has been a complete failure.”
There are a lot of reasons for this: Information is far from perfect in an extremely vast and complicated economy, and it’s far from free; the time costs of gathering, evaluating, and learning complex technical information can easily be prohibitive. But also, often you can make so much money in the short run that it’s worth hurting your reputation (to the extent that it’s hurt and that people you deal with will know and understand). I mean how many CEOs and top execs are in their 50s, 60s, and 70s. They’re going to be retired relatively soon anyway. There’s not much of a long term for them to suffer in exchange for gigantic short term gains. The harm they will do will live on long after they retire and don’t care, and much of it won’t even be to their company but to their customers, and the economy through great externalities.
I had a nice related post a while back that was in Mark Thoma’s links, “More precisely, it’s “Guys who LOOK nice finish first”, at:
http://richardhserlin.blogspot.com/2008/10/more-precisely-its-guys-who-look-nice.html
Continuing down the post:
“The next day the plan was revealed, and christened “the Volcker rule.” What better way to lure Republicans onto a populist, antibank bandwagon than to associate it with the legendary Reagan-era figure?” — Luskin
Volcker was origonally appointed Fed Chairman by Jimmy Carter.