Yeah, I know. Funny, I was going to quote exactly the post you did in a (now discarded) response from yesterday.
Although I would point out that if one maintains the orthoganality of “free” and “regulation”, gonzomax’s point is certainly arguable.
I thought it was quite relevant, as you were comparing individual rationality with aggregate measures.
My point was really that you can’t call ANY of these things the cause, or even the primary cause. They are all interrelated. It’s a systemic issue, and not one in which you can just say the problem was ‘deregulation’, or ‘too much regulation’, or ‘free markets’, or ‘government’.
There are parallels to the S&L crisis, which is simpler, so maybe easier to use to illustrate the principle. Some have said that the failure of the S&L’s was because of deregulation and a failure of capitalism. Others have said that it was the fault of governments intruding in the marketplace.
In fact, it was both. The problem was very similar to what we see now - a system was set up in which the S&L’s were free to profit on the open market, but failure was protected by government. To keep it in balance, the profit-making side of the S&L’s was heavily regulated. Then Republicans came along and de-regulated the profit-making side, while leaving the government protections against failure in place. The result was a situation in which an S&L had very little incentive to loan only to responsible people - if they got paid back, great. If not, well, the government had their back with $75,000 in default protection. It also left a great gaping hole for con-men to crawl into - if the government will pay you back for defaulted loans, what’s to stop you from giving a loan to a corrupt buddy, letting him default, and collecting both the loan money and the government cheque?
Had the government not been there to pay off the bad loans, the deregulation might not have been a bad thing. Had the government not been there to protect against defaults, regulation on the profit side would have made the S&L’s non-viable. So it wasn’t deregulation or government that was to blame - it was the specific mix of poor regulation and government guarantees.
The same is true in the current markets. So long as government is backstopping the loss side, the risk of inadequate regulation is that the market willl run wild without reasonable checks and balances on risk-taking.
It was Hayek that pointed out in “The Road to Serfdom” that government interference in markets creates the need for more government interference - that’s the definition of the road to serfdom. His point being that intrusions in the market create imbalances, which, left to their own devices will cause distortions and unintended consequences, requiring ever more government intrusion to prevent them. We’re seeing that in practice right now.
Don’t mistake me for saying that the fault is with government. I recognize the need for governments to be involved in regulating the money supply and protecting deposits to a certain extent. If we went back to a gold standard, there’s no way in hell we would have seen the kind of economic progress we’ve seen over the last half century, as capital would have been too difficult to move and would have been a constant contraining force on our economic output. But even given the acceptance of the need for government, you can point to situations where governments over-reached - Fannie Mae and Freddie Mac being the best example. And you can also point to situations where misguided free-marketers advocated deregulation of half of a quasi-free market, creating an imbalance that allowed clever financial people to run amok.
A more difficult issue is whether or not modern financial markets are so complex that they’ve outstripped the ability of government to regulate them effectively. If that’s the case, then perhaps the answer going forward is remove government as much as is reasonably possible from the protection and guarantee side of the equation so that more natural checks and balances are created, allowing the market to regulate itself and minimizing the risk of the kind of ‘hidden’ financial system that’s got us into this mess.
Thanks for the post, Sam. I always enjoy reading them. And if you have a moment in the future, I’d like to hear your thoughts on the gold standard and why it would make capital ‘too difficult to move’.
But to add to your point, I would offer the following…
Even if financial markets aren’t complex, the government can still screw up it’s job of regulation in a royal way. Whenever you bring in a 3rd party with supreme oversight and power into an equation between two other parties (in this case, borrowers and lenders/savers) you are reliant on that party’s capabilities, work ethic, incentive structures and accountability.
As we have often seen with government regulators, those things are (in order) little-to-none, unknown, none, and none.
Here is a list of bank failures in the US, from the FDIC’s website.
http://www.fdic.gov/bank/individual/failed/banklist.html
Some of the names might be familiar (e.g. IndyMac). Some may not (e.g. Integrity bank in Alpharetta, GA). But all were regulated. And in the case of Integrity bank, their business model was pretty simple. They gathered brokered deposits and loaned like hell to the construction and development industry. You can get downloads of the post mortem in American Banker and other private sources. That is, as much info as can be gleaned. Because a lot of this isn’t available to anyone other than the regulators and bank insiders.
76% of Integrity’s loan portfolio was in construction loans. Any bank manager worth his/her salt will close their eyes, hang their head, and shake it in disbelief when they hear that. You should never, ever, ever concentrate your loan risk to such a degree. You are asking for trouble if you do that. And trouble is what Integrity bank got.
So why did the regulators allow that to happen? Beats me. Maybe they were incompetent. Maybe they were bribed. Maybe they were just lazy and went through the motions as part of their regular exams, and then hit the golf course. We’ll never know, because their reviews are not available to the public.
The point is, many of the banks on the FDIC ‘failed’ list were operating under extremely simple, but obviously risky, business models. And there were regulators in there all the time. They didn’t prevent failure, that’s for sure.
So why would you give an agency like that MORE power? Why would you reward such failure with MORE authority?
Sam, thanks for resonding directly. I’d have done the same (in as lengthy a fashion as I did for IdahoMauleMan) if you’d asked for clarification. While typing this up, I realized that often little, if any, distinction is made between free markets and free marketeers (defined here as those who advocate deregulation, usually making no distinction between “good” and “bad” regulation). So, the first thing to note is that I’m emphatically not attacking capitalism per se, nor free markets in general. Besides having only a layman’s understanding with which to do so, I haven’t the desire – laissez-faire may be too much, but some form of capitalism really is the engine that drives the world.
I am, however, attacking “free marketeers” and, more generally, those who defend them. Whether or not I’m attacking you remains to be seen; at this stage, let’s call it “probing you for more information”.
So fine, all these things are interrelated. No argument there…really, how could there be? The substantive arguments come on two fronts: (1) discussing future action to fix the issues and (2) apportioning blame for this crisis. Much of your posts deal with (1)…for instance, the part that immediately prefaced what I’ve said was a “concise summary” that was “spot on”. What follows – which, coincidentally, is a broader view of the OP’s question – addresses (2).
The reason I negatively criticised the parts that I did is that it seems to me that you’re taking up the mantle of defending “free marketeers”. My sense is that you attempt to dilute due blame, to shift responsibility from the white knights of big finance to wherever else you can. Not all of it, mind you, as that’s a fool’s task that’s simply not possible. And you’re not a fool. But enough to allow you to benignly say, for instance, “It [the financial crisis] looks to me like a learning opportunity.” Or, “It’s a systemic issue”, thereby neatly avoiding any distribution of blame. Or, slightly more expansively, with attempted even-handedness:
But it’s not so even-handed, if you examine it. The clever free-marketers were simply misguided (although they did run amok). An imbalance was created. Ultimately, it was only a quasi-free market to begin with…which, of course, is due to government mucking it up (which I’ll grant, but evades the point). And that’s the worst, to me. That you set your argument up such that you can don Bambi-eyes, shrug innocently and helplessly, and say things akin to, Really, can you blame the financiers for taking risks when they knew the government would bail them out?
Why, yes…yes, I can. And I do. And so should we all.
If I recall correctly, in many arguments concerning capitalism, you often present the caricature of the “evil business owner” (sometimes with the flourish of “twirling their mustache”) as a way to trivialize the opposition’s position. Personally, I know that’s false and have a pretty high opinion of running a business; I find it rather insulting when you resort to it. However, I’ve worked for Wall Streeters (consulting work for Goldman, Kidder, 1st Boston, etc., although now more than a decade ago) and I also know through personal experience that the “greedy Wall Street fat cat traders” isn’t that much of a caricature; in fact, it’s a pretty fucking accurate description in a lot of cases.
With my lengthy exposition out of the way, before going further, let’s get clear on something. When you use the term “regulation”, what does it entail? You’ve explicitly said that there is a necessary role for government in the financial system. You’ve also explicitly said that you feel that not all regulation is “bad”. It’s not clear to me where that line gets drawn for you, beyond some nebulous acknowledgement of an ethereal need for it. Is there a principle involved (outside of “as little as possible”)?
Let’s take, for instance, your citation of Sarbanes-Oxley, made in a clearly derogatory sense. I have only a limited understanding of it (all from the Wikipedia entry), and so will use it to kill two birds with one stone – besides getting an idea of what you consider “bad” regulation, I’ll hopefully pick up some knowledge. From what I gather, SOX is meant to be “good” regulation, increasing corporate accountability and transparency. Just like what you called for when you said “What we need is a financial system in which there are regulations which require investment risk to be transparent.” If you can’t convince me that SOX is actually bad, that you do not fall into the “any regulation is bad regulation”, then you’ll have to excuse me when I dismiss your credibility in apportioning the blame for the current crisis (no matter how sound your suggestions on economics are).
After all, once again, that’s the kernel of what the OP is asking, isn’t it? To my recollection, whenever any hint of regulation rears its head, there’s an immediate and intense outcry against it (from “free marketeers”, not necessarily here, nor necessarily by you). IMO, that’s what the OP was asking – not “What do we do now to fix this thing?”, not “How did this happen?”, but rather: “Of those who raise a hue and cry when any mention of regulation comes up, have any recanted?” It seemed crystal clear to me; what’s not clear is why so few also thought so.
We’re already way beyond that, though, and I don’t mind continuing this track if you don’t.
Oh, and IdahoMauleMan, since you’ve jumped off Sam’s last post, I’ll do the same with my response to him. Was my response to you sufficient?
The obvious question that occurs to me concerning the failed banks you mention (a question due to my readily admitted ignorance) is: what does it mean when you say, “But all were regulated”? One might make that statement about any and every (legal) lender in the U.S., as all are subject to usury laws. Obviously, that’s a ridiculous point and not what you mean, but it would be nice to have more information before being able to make any argument whatsoever concerning the power and/or authority of regulators (much less their incompetence, as you express).
Thanks for the response.
I’m struggling to understand what you where getting at in your post. And it sounds like you were struggling to get at what I meant as well. Maybe I could try again, and if you wouldn’t mind, so could you.
Other than military conscription, the operation of the judicial system, and the tax revenue required to pay for those, financial regulation is the one area where you should be able to get close-to-100% agreement from just about anybody that regulation is required. At least a financial system that is off the gold standard. Anybody who says otherwise should really be grilled for ‘why’ they think otherwise.
Even the hardest of hard-core libertarians agree that some tax revenue, somehow, needs to be raised and some government oversight must exist to develop a common defense and judicial system. Check. So let’s move onto the financial system.
We have a legal system fractional-reserve banking. What that means is that a bank, at any one time, is owed far far more by its debtors than it has in it’s ‘vaults’, so to speak. At least 10 to 1 in the case of most community and regional banks. 12-15 to 1 for bigger regionals. And of course, as we all know, ratios of 30+ to 1 existed for some of the big boys that went belly up (Lehman, Fannie and Freddie). The quality of these banks’ loan books is critical to determining their solvency at any one point. For example, if a bank has a 10 to 1 leverage ratio, and 10% of their loans are going to go bad, they effectively are bankrupt and won’t be able to pay their depositors. I’m drastically oversimplifying this, of course, but I’m doing so to make a point.
So what to do? Some options are to
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Go back to 100% reserve banking. Murray Rothbard would argue (posthumously, God rest his soul) that this is the only ‘legal’ option, since fractional-reserve banking is a brazen fraud in-and-of itself. His reasoning always makes me smile. But this approach seems impossible. I can’t even comprehend what the transition from here-to-there would look like. I have a feeling it would be ugly. You would basically have to call in 90+% of your loan book, across the banking system, to be paid in full.
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Remove FDIC insurance and let the chips fall where they may. If assets (loans) go sour, depositors are hosed. This is basically what unregulated hedge funds are going through right now.
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Impose a basic set of standards on lending and deposit-taking practices. Such as maximum LTV ratios, minimum % held for securitized assets so that lenders have some ‘skin in the game’, etc. This runs the risk of stifling banking innovation (e.g. what is the ‘V’ for a future stream of David Bowie album releases?).
Also, whenever banks start to get too conservative there is usually some community action group that starts to pound the table, insisting not enough credit is being extended to underserved communities. That’s how Fannie and Freddie got started in the first place. We know how that ended.
- There’s lot of other levers you can pull, or knobs you can turn, but I’m out of time here.
I’m a big fan of maximum disclosure. I don’t know why banking regulator reports shouldn’t be made public, with signatures of the regulator on the report for everyone to see.
The stated reason is that they don’t want to cause ‘panics’ and ‘bank runs’ due to a poor report. Well, what is the alternative? To let a poorly-managed bank go down the tubes, and then put us on the hook for even more?
There are some decent systems in place for evaluating public ‘regulators’ like FAA check ride instructors for pilots. Their pass/fail ratios are expected to be within a certain range. If they fail too many people, they need to be re-checked by a peer group to ensure they aren’t being too tough. If they pass too many people, the same thing needs to happen to ensure they aren’t being too lenient. There is absolutely no transparency of any sort into banking regulation whatsoever. And I know a lot of banking regulators. Some of them are pretty good. I wouldn’t trust some of them to regulate a lemonade stand, much less a bank. But they will never be fired.
So my fundamental point(s) are:
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The genie is out of the bottle with fractional-reserve banking. And we haven’t even talked about fiat money yet. The banking system must be regulated when that’s the case, or else you have to accept that depositors will lose their money on occasion. Pick your poison.
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There is nowhere near the disclosure and accountability possible for government regulators. They wall themselves off in mysterious corners and don’t make any information available to the public. There is no real leash to hold them accountable. How do you know if they are doing a good job? Or a bad job? Or if they need more resources? Or if they need less resources? Answer: You don’t. You have no idea. Once they get launched, they essentially become self-governing entities.
Come to think of it, I would like to apply that second paragraph above to government regulation in the broadest sense. The FDA. The CPSA. The Division of ATF. You name it. But let’s save that long story for another day.
You’re welcome, most likely, and most certainly. 
You (explicitly) springboarded off Sam’s post with a list of failed banks, mentioned that these banks are regulated, and then severely criticized bank regulators. It’s my sense (correct me if I’m wrong) that this was meant to be a prime example of how “regulation” can screw things up.
But I don’t know what that “regulation” is. I can’t even hazard a guess as to what you’re referencing, thereby making any comment by me an exercise in idiocy by way of ignorance. So I was just asking for clarification, not having enough information to even begin to determine whether I’d argue or just “Me too!” your sentiment.
If all you’re saying is that there should be more transparency and/or accountability in the system, I can only emphatically cry “Me too!”. 
I can tell you what it would look like: retarded. But there’s no need to force banks to do this to see how it gets weird. You can do it yourself, if you ignore the fractional-reserve backend for a moment. Here’s what you do…
First, take a look at your credit. Let’s say you have about one years’ worth of salary available as credit on demand. Then you take one years’ salary, and you get a secured credit card by depositing this in the bank that issues the card. Finally, you cancel all your other debts. Voila! Everyone is guaranteed to get their money, even if you’re an unreliable sod. Of course, there’s the massive opportunity cost associated with an entire years’ worth of your money sitting around doing nothing, but hey, it’s the only “legal” option, right? It must be good. 
Even more? It isn’t like this is a zero-sum game here. Are you supposing that there’s been no other social benefit for this situation at all?
Or saving will suddenly become a direct cost, as banks, being unable to profit from reinvesting from their reserves, will now have to charge you to hold your money. If easy credit encourages spending, what does expensive saving do?
Good question. But this is a problem with the form of regulation, not a problem with regulation.
Credit cards.
That was a terribly, sloppily written post on my part. And was poorly organized. I wanted to create a couple of buckets with options:
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The ‘more/smarter regulation’ bucket of options (established lending standards, higher capital requirements, transparency and accountability of regulatory reports)
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The ‘less regulation’ bucket of options (no regulation at all, let the chips fall where they may, or go back to the gold standard)
But I did a crappy job. Sorry. And I don’t have time for a properly edited long response now, either. Hope the interest in this is still there when I get back.
No worries. And my interest is pretty steady…I don’t enter into a conversation that I’m not prepared to follow to its conclusion.
Speaking of which, are you still out there Sam? Honestly, I really was hoping to learn something about SOX, particularly from someone who views it as over-regulation. Even a decent cite would be appreciated if you don’t want to respond to anything else I wrote, as Wikipedia was both overly brief and seemingly innocuous…and I don’t have the time to wade through a bunch of low-information, googled links.
I was specifically talking about "Mark to Market’ rules. It’s late, and I’ve got to get to bed, but here’s an article in Forbes you might find interesting.
Thank you. It’s not clear to me that this should be taken up in depth in this thread, as it seems like a separate topic, but…what the hell. If pursuing it grates on anyone, please, don’t hesitate to start a new thread and link to it. And now that I’m done writing it, I realize it’s really fucking long and don’t expect many to sit through it. I’d ask you, Sam, to do so, as I felt your cite was worth my time and would expect you to give me due consideration. Two things:
(1) Am I to understand that you do not have issues with SOX beyond the mark-to-market requirement? I ask because I’ve read scathing remarks elsewhere about it, but no supporting reasoning that I could discern. And I’d still like to learn about it.
(2) So, to the meat of my response. Since Gingrich presents an argument, the need for regulation in this case is arguable (by definition). Here’s what I don’t understand about the complaint – isn’t it diametrically opposed to the underlying ideology? In fact, isn’t making the argument another example of “privatize gains, socialize failure”? That is, for a hard-headed capitalist, if the market value drops precipitously, well…tough shit, the market has spoken. For evidence that you, Sam, engage in exactly this type of hypocrisy, I give you your defense(s) of price gouging. I have no doubt you’ll give me reasons why the ideology applies to one but not the other. I doubt, though, that you’ll convince me that you’re not just being a hypocrite…but have at it if you’d like.
But let’s not stop at your own personal blind spots; let’s go to your citation itself. Personally, like George Will or other “conservatives”, I don’t mind reading Newt’s arguments. He’s a smart guy. I find many (most?) of his positions laughable, but at least he makes me think. He says:
Yeah? And? Isn’t that the proper role of the “invisible hand”?
Gingrich traces the effects (which seems like an accurate description to me), then says, “The criminal liabilities imposed under Sarbanes-Oxley have driven accountants to stricter and stricter accounting evaluations and interpretations and have prevented leading executives from resisting them.” Again…yeah? And? Unless I misunderstand, this is exactly what “transparency and accountability” regulation requires (that I note again you call for, Sam). The alternative is to explicitly not value things at market prices. WTF?
And don’t misunderstand me. I understand the downward spiral explained in the Problems section and I’ll get back to that. First, I just wanted to skip ahead a little bit to bring up the following little beauty:
Donning my “cloak of sarcasm”, hey – I have an idea: let’s price gasoline at a three-year rolling average also! As near as I can tell, that would put it at about $2.50/gallon right now. Yay us!
What a fucking schmuck.
Back to the downward spiral. Fine, let’s agree that this is a crisis that requires extraordinary measures that would be otherwise unacceptable. Suspending mark-to-market might help the situation. I’ll try to overlook my feeling that temporarily suspending actual market valuation makes those supporting it look like petulant children – “Time out!” they cry when the game doesn’t go their way. More substantively, suspending mark-to-market seems like a sneaky way to reduce losses (otherwise known in your terms as “government protected failure” or, more colorfully, as “sucking from the taxpayer tittie”, assuming the government will be the one buying these things).
Let’s look at Wikipedia’s page on discounted cash flow, which is proposed as the way to value these assets. There’re an awful lot of assumptions involved (risk level, time frame, discount value). Does anyone think that these assumptions won’t be tweaked to the benefit of the market players?
Worse than that, IMHO (and I’m way beyond the limits of my knowledge here, so my “humble opinion” may be wildly off base), is that this is similar to the “Drill, baby, drill” solution to energy independence. If done with any semblance of accuracy, it won’t have an immediate effect, as it’ll take time to determine appropriate valuations. Isn’t a substantial issue in this crisis that no one knows what’s in these securities? One might argue that some fictious value is better than none for the purpose of “getting the market in motion again”, but really…isn’t that what risk-taking investors do? Find the undervalued deals and make buttloads of money when they reach their potential? But doing so requires information; as I understand it, that information just isn’t available right now. Come to think of it, this seems like a very sneaky way to just maintain the current veil of ignorance. CYA, security through obscurity, as then no one can really tell just how bad things are; but that doesn’t even rise to the level of believable conjecture, more like an ancillary benefit. Consider that just an aside.
Furthermore, isn’t it true that the mortgage-backed securities (read: sub-prime loan failures) were only the initial, but relatively small, genesis of the problem? That is, valuations of financial instruments that are not directly tied to real property can only be wildly guessed at. At least with real assets, one can base a valuation on the terms of the loan/contract. What terms does one use for a credit default swap?
Extracting myself from that lengthy exposition, the truly wonderful thing about free markets really is the invisible hand. A complex system that regulates itself (note: “regulates” not as in “subjected to rules or laws”, but as in “ebbs and flows”). Eliminating mark-to-market eliminates exactly that ebb and flow by attempting to impose valuations via calculations and guessing; much better, IMHO, to buy equity and let the invisible hand do its thing. If the equity disappears as a business goes under, so be it. However, in those places where the equity grows, then the investor (i.e., the taxpayers) benefit. It seems to me that that is what a believer in free markets would advocate.
With all that said, what pisses me off the most about your cite is the close-out, where Newt springboards from the above hypocrisy and asininity, basically launching into the ever common refrain of tax cuts for the wealthy. And gets in a shot about repealing SOX to reduce corporate operation costs – except that his reason for doing so is that SOX “failed to warn of every single bankruptcy”. Isn’t that a total disconnect? Per my understanding, SOX mandates transparency and accountability…where/how is it supposed to warn of any bankruptcy? That’s the fault of the idiots who ignored what was out there (whether found in SOX reporting or elsewhere). Great googly-moogly, it must be an example of the reflexes that sailor mentioned.
So, yes, Sam, I found your cite interesting and I thank you for it. I find it totally unconvincing, misguided, and confirming my opinions of: (1) how “free marketeers” (and those who defend them) are ethically and ideologically bankrupt and (2) just how much of a tool Newt is. But interesting, nonetheless.
In answer to the OP, the 10/23 NYTimes had the following article Greenspan Concedes Error on Regulation (free reg. required). Specifically, the following bits:
I watched a bit of the Congressional hearing dog-and-pony-show on C-Span today. I saw a bit of Greenspan’s Waffling testimony. One of the questions had to do with the apparent change in tone in his book between what he says in the book and what he says in the epilogue. (I didn’t read the book.) I couldn’t understand the answer, maybe someone can translate Waffle into English for me.
Watching Cox skip around his 2004 policy change that contributed heavily to this mess would put the World Champion triple jump and hopscotch champions to shame.
Back to the OP, has any notable economist said anything to the effect that due to the current economic mess I am going to rethink and rewrite my theories because current events have proven that I had it wrong?
Here’s Brad DeLong’s brief treatment about theories of the Great Depression.
Greenspan was in front of the house committee today. He said his ideology may have kept him from doing what was needed. He has rethought and now believes that regulation is necessary. Now we have to decide how much. He was amazed at the greed. How could he be?
[Professor Frink] I, uh, forgot to carry the one. [/PF]
Paul Krugman has also had his second thoughts, IIRC.
Here’s another link from Brad DeLong:
http://delong.typepad.com/sdj/2008/09/delong-smackdow.html
And another:
http://delong.typepad.com/sdj/2008/10/delong-smackdow.html
Thanks for the DeLong links. From 10/23’s entry, he links approvingly to ThinkProgress’s Cox, Greenspan, Snow Agree: Freddie Mac And Fannie Mae Did Not Cause The Financial Crisis, which says:
Harking back to my post #85, that’s not to say that Fannie/Freddie weren’t contributing factors, but simply that they do not bear the majority of blame.