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:
- 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?