April 18, 2008
If it’s broke, fix it - but how?
The failures of the western financial models
The worst outcome of the current financial crisis would be a return to the status quo ante that produced the pathologies, anomalies and contradictions that are its root causes.
I believe that the Western model of financial capitalism - a convex combination of relationships-based financial capitalism and transactions-based financial capitalism - has, in its most recent manifestations (those developed since the great liberalisations of the 1980s), managed to enhance the worst features of these two ideal-types and to suppress the best. This period has been characterised by a steady increase in the relative dominance of the transactions-based financial capitalism model in the overall financial arrangements of the world, most spectacularly in the US, the UK, and such smaller countries like New Zealand and Iceland, somewhat less in most of continental Europe and elsewhere.
The key policy issues created by the recent excesses of the financial sector, once the immediate financial crisis has been euthanised, are those of governance and regulation. Governance issues include prominently the question of remuneration for top managers and superstars. I will not address this issue here. Regulation (and public ownership) inevitably become issues in all industries where widespread, systemically significant externalities, free rider problems and public goods features ensure that decentralised, competitive outcomes are inefficient. They are especially acute in the area of financial intermediation, because leverage permits the scaling up of financial activity to astronomical levels in no time at all. The damage that can be done by a rogue individual, a rogue firm or a rogue instrument is unparalleled among legal business activities.
Financial intermediation is playing with fire; there is no escape from this. Any economic activity undertaken for profit or power which has trust and information as its two key inputs is bound to be vulnerable to abuses, distortions, excesses and deception.
Effective financial intermediation is also a key and necessary feature of any economic system capable of delivering sustained increases in material well-being. If every economic agent were required to be financially self-sufficient, we’d all still be living in trees.
Getting ex-ante financial surpluses from economic agents whose planned saving exceeds their planned capital formation matched efficiently with the ex-ante financial deficits of economic agents whose planned capital formation exceeds their planned saving can, given time, increase the productive efficiency of an economy by orders of magnitude.
Transactions-based financial capitalism emphasizes arms-length relationships mediated through markets (preferably competitive ones), is strong on flexibility, encourages risk-trading, entry, exit and innovation. It is lousy at endogenous commitment: reputation and trust are not a natural by-product of arms-length relationships. Commitment requires external, third-party enforcement.
Relationships-based financial capitalism emphasizes long-term relationships and commitment. It has, however, compensating weaknesses. Investing time and other resources in building up relationships with customers creates an insider-outsider divide that is very difficult to overcome for new entrants. It also encourages, through the interlocking directorates of the CEOs and Chairmen (seldom women) of financial and non-financial corporations, a cosy coterie of old boys for whom competitive behaviour soon no longer comes naturally. At its worst, it becomes cronyism of the kind that was one of the key ingredients in the Asian crisis of 1997.
The financial system that during the first decade of this century ruled the roost in the US, the UK, increasingly in continental Europe and in its outposts in Australia, New Zealand, Iceland etc., combined many of the weaknesses of the transactions-based system (opportunism, myopia, lack of commitment), with the worst features of the transactions-based system - a dreadful clubbiness and homogeneity of outlook and perspective, and a ruthless closing of ranks when the sector as a whole was threatened with legislation or regulation. Let me just remind you of some of of the issues that prompted vigorous lobbying: the taxation of non-doms; taper relief under the UK capital gains tax for private equity magnates; tax havens; proposals for reporting obligations, transparency and audited accounts for highly leveraged financial entities above a certain size, regardless of their legal nature and regardless of what they call them selves; anti-cyclical capital adequacy requirements and liquidity requirements for highly leveraged entities.
It’s time to learn from these lessons and to act on what has been learnt. Acting now would not mean rushing into hasty if-it-moves-stop-it forms of regulation. We have had 20 years to think about this. It is clear where the problems are. In the past 20 yearns, the financial sector has, starting as a useful provider of intermediation services, grown like topsy to become an uncontrolled, and at times out-of-control, effectively unregulated, hydra-headed owner of licenses to print money for a small number of beneficiaries. The sources of much of these profits turned out to be either a succession of bubbles or Ponzi schemes, or the pricing of assets based on the belief that risk disappeared by trading it. This belief that there is a black hole in the middle of the financial universe that will attract, absorb and annihilate risk if the risk it packaged sufficiently attractive and sold a sufficient number of times is closely related to the firm conviction of every trader I have ever met, that he or she can systematically beat the market. The fact that all traders together are the market did not constrain these beliefs. General equilibrium and adding-up constraints are not the markets’ forte.
So is tighter regulation of the financial sector, and especially of highly leveraged entities above a certain size the answer? It would be part of the solution if we could find and keep the right regulators and design and implement the right regulations. Here, however, I hit a blind wall.
Quis custodiet ipsos custodes?
Who polices the police or, more to the point, who regulates the regulators? No doubt they are formally accountable to some departmental minister or even to Parliament/Congress. But does that fill me with confidence their their actions will promote efficiency and fairness? No, it does not. If regulation is to be effective, it may have to be hands-on and quite intrusive, if only for the regulator to acquire the information (s)he requires to make an informed judgement.
Effective supervision runs into some rather impenetrable obstacles.
First, a $5 million dollar a year trader will run rings around a $150,000 a year regulator.
Second, regulators involved in intrusive and hands-on regulation are virtually guaranteed to be captured by the industry they are meant to be regulating and supervising. This regulatory capture need not take the form of unethical, corrupt or venal behaviour by the regulators or members of the private financial sector. It could instead be an example of what I have called cognitive regulatory capture, where the regulator absorbs the culture, norms, hopes, fears and world-view of those whom he regulates. We cannot just appoint ethical Vestal Virgins to be regulators, regulators who start out pure and stay pure despite their daily associations with people who don’t instinctively play by the rules of the House of the Vestals
Third, even if (1) and (2) don’t apply, regulators will serve their own parochial, personal and sectional interests as much as or even instead of the public good they are meant to serve. No bank regulator wants a bank to fail on his or her watch. As a result, either excessively conservative behaviour will be imposed by the regulator on the regulated bank or other financial intermediary (ofi), that is, we will have if-it-moves-stop-it-regulation, or the regulator will mount an unjustified bail out when, despite the regulator’s best efforts at preventing any kind of risk from being taken on by the regulated entity, insolvency threatens.
I don’t know the solution to this conundrum. To minimise the risk of the first two problems emasculating regulation, any regulation will have to be as much arms-length and impersonal as possible, rather than invasive, intrusive and hands-on. A further key requirement is that institutions that are deemed too big and too systemically important to fail should be de-coupled from their owners and their top management if a publicly organised and/or funded rescue effort is mounted.
So any institution-specific support operation should require that the entire board and top management resign and leave without even a bronze handshake, the minute an agreement is reached. A special resolution regime (along the lines the FDIC runs for insured deposit-taking banks) with Prompt Corrective Action and a special form of regulatory insolvency that can be invoked by the regulator before the financial entity at risk is balance sheet insolvent or cash-flow insolvent. The shareholders should get nothing up front, but would have to take their place at the end of the line of claimants to whatever value can be realised under the special resolution regime.
The regulator as deus ex machina, doing his philosopher king bit in the disinterested pursuit of the public good is a dangerous fiction. Attributing competence and disinterested benevolence to regulators is as sensible as relying on self-regulation by the financial sector. So there will have to be a messy compromise. Clearly, things got badly out of hand in the private financial sector this past couple of decades, and the sector’s capacity to take on excessive risk will have to be restricted severely if we are to avoid another credit orgy of the kind we saw during the years 2003-2006. But am I confident that regulators will do more that bolt the door after the horse has bolted – never to return? I am not. But I am ready to be pleasantly surprised.
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The issues you raise regarding how to attract and retain individuals who can stand up to traders and executives and avoid absorbing their charges’ mindset seems insurmountable, but let me offer a partial solution.
Women who’ve been in the industry.
I hate bringing up gender (the stereotyping is pervasive) but women have much lower odds of making it to the top and getting the same comp for their work as the boys and they are acutely aware of it. Many of the women I know who are in or have been in the industry don’t buy into the culture because they are ever and always outsiders.
Reports from boards in the US and Australia say that women directors are far more inclined to do their homework and ask tough questions than men are. Boards are as clubby as you get. If women aren’t cowed in those settings, that suggests they might also stand their ground in regulatory roles (the horrific example of Sheila Bair notwithstanding).
Women who’ve performed well in the City or the Street often find it impossible to work out part-time positions when they want to have children, except in those rare admin jobs that require substantive knowledge. You can get good women on the cheap with well-designed mommie track roles. Regulators should sit up and take notice.
Posted by: Yves Smith | April 18th, 2008 at 3:42 am | Report this commentHere’s a couple of sensible non-starters:
1. Tax all financial transactions and corporate income to allow for the funding of independent auditors, ratings agencies, and regulatory bodies.
2. Create substantial mandatory jail sentences for felons concomitant with the confiscation of all assets.
Posted by: SS | April 18th, 2008 at 6:36 am | Report this commentThe tension between the stability of a coalition of elites -relatively closed to outsiders - and the instability of a more open ‘transaction-based’ market system, is a defining issue in society. It is remarkable that the Anglo-Saxon countries have held together without the glue of a self -perpetuating elite. This successful spontaneous order is what fascinated Tocqueville about America.One dominant thread that runs through Chinese history, on the other hand,is a deep fear of the chaos that might result from a breakdown of traditional Confucian hierarchical order -and with the Cultural Revolution still in memory for many Chinese, one can understand why this fear persists.
The disadvantage of societies organized around ‘relationship’ coalitions is that they are less free than ‘transactional’ societies. The relative prosperity attained in a transactional market system flows from the spontaneous organization of activities enabled by this freedom.
Hayek dated the emergence of a transaction based price system to the time the first out-of-town caveman appeared with goods to trade. The beginning of civilization is marked by the advent of impersonal trade. As our world economy integrates to an unprecedented extent, impersonal trade becomes ever more prevalent, nowhere more so than in finance, where Prof. Buiter points out, we are playing with fire.
Prof. Buiter poses the question of how to retain the advantages of a transaction based finance system while imposing a level of commitment to keep a lid on things. Must it be a third party? The answer is: We don’t really know how to do it. Madison thought he found a solution in Federalist Paper 51, with the creation of a democratic government -reflecting the permanent interests of the people -constrained by a separation of powers within government and a written Constitution protecting citizen rights. That seems to be eroding as the American government has become far more intrusive in property rights than the Founding Fathers intended and more prone to regulatory capture and populism (lest we forget that Lincoln made his case for emancipation on the premise that the Negro had a God given right to the fruits of his labor -whatever he could command in the marketplace).
To some extent, of course, the market will heal itself. A lot money has been lost in recent times and self-interest ought to lead to systemic reforms. What makes finance a somewhat unique industry is that the private incentives to reform may not match up with the external social costs involved.That is why Prof. Buiter’s conclusion that the best outcome is to muddle along between the two systems is plausible. But there is a trade-off.
As the financial markets become more constrained by regulation they may become more stable, but we will become less wealthy (than under a transaction based system). There is a real choice here that cannot be fudged.
Posted by: Daniel J. Aronoff | April 18th, 2008 at 7:39 am | Report this commentWhat’s preventing financial regulators from barking?
Billions, if not trillions in public funds are disappearing around the world.
But the main difficulty seems to be a lack of political support for regulation. The culture that destroyed auditors Arthur Andersen and dissuaded other ‘independent’ regulators? Fortunately the new Scottish government is currently investigating audit arrangements.
Posted by: Slightly Optimistic | April 18th, 2008 at 10:02 am | Report this commentIt seems a false choice to suggest that additional regulation provides less wealth (overall) than an unregulated or lightly regulated transaction based system that fails so spectacularly on a periodic basis. The estimated trillion dollar cost of this crisis alone would fund certainly fund third party oversight bodies for decades.
Posted by: SS | April 18th, 2008 at 10:51 am | Report this commentThis is another comment from naked capitalism worth reading
We have the rare spectacle of Willem Buiter admitting he doesn’t have an answer, but in fairness, he is looking at a throny problem.
Buiter considers the question of what to do about the financial sector once the crisis has passed. He provides a scathing assessment of the workings of financial capitalism, but is pessimistic that regulation can be effective. Highly paid traders will outsmart supervisors; regulators, out of prolonged contact with their charges, will be corrupted intellectually, identifying overmuch with the industy’s world view; the minders will be inclined to one of two extremes, either to restrict bank activity unduly, or to go too far overboard in their salvage operations should anything bad happen.
There is a flaw in Buiter’s reasoning, however: he assumes the status quo ante will return in the absence of government intervention. Enough pieces of critical infrastructure are hopelessly impaired that I doubt that will happen.
The biggest, and one that poses a major conundrum, is that private securitization has ground to a halt. It depended on credit enhancement, which is now suspect, and has also become scarce and costly. The monolines are no longer in that business; with bank balance sheets impaired, there are far fewer credit default swaps protection writers. Plus, given concerns about counterparty problems leading to more generalized failures in the CDS market, it’s not clear how receptive investors would be to CDS as the means for providing credit enhancement.
Plus with so many investors burned directly or indirectly by supposed AAA paper that fell rapidly from grace, it may take a generation before memories fade and willingness to buy the product returns.
So in the US, we see Fannie and Freddie stepping into the credit enhancement breach, even though that will soon create problems of its own.
That is a long-winded way of saying that the industry is already losing important businesses that led to high profits, swagger, and outsized pay. Give it two more bonus cycles, with the attendant job cuts, and you’ll see a humbler, easier to contain players.
The critical step seems to be to recognize that banks (both the investment bank type as well as traditional commercial banks) are wards of the state and to treat them accordingly. That in turn means not being hesitant to restrict the scope of their business. If you want to take risks, fine, go be a private partnership and don’t expect any help if you screw up.
My short list (some of them cribbed or adapted from a proposal by Amar Bhide) of what to do would be:
1. Force as much OTC activity as has reasonable trading volume onto exchanges. That means at a minimum interest rate swaps, currency swaps, and credit default swaps. Yes, this will require standardization and some buyers will lose access to variants they might have liked. Too bad. Protecting the economy and the taxpayer is more important than indulging every investor’s pet need.
This of course will also considerably lower the profitabilty of the industry. Again, too bad. They screwed up and cost the populace a ton of dough. There are consequences for mistakes of that magnitude. They should consider themselves lucky not to have been subject to public beheadings.
Lower profits for banks has positive consequences. It means less talent and other resources are sucked into the FIRE economy (and remember, the FI in that equation are at best service providers to the real economy, and worse, when they become too large, parasites).
2. Prohibit off balance sheet vehicles.
3. Prohibit Level 3 assets; allow only Level 1 and strictly defined and audited Level 2 assets. This means regulators will not have anything overly arcane to assess; they ought to be able to get a clear picture of risks, processes, and exposures if they are dogged.
4. Prohibit these regulated institutions from lending, providing other funding, or investing in concerns that have Level 3 assets.
Hedge funds would continue to be unregulated. I might also prohibit any unregulated entity from going public. Speculators playing with investors’ money is tempting enough; having them have even less skin in the game via a public floatation makes it easier for them to get so large as to pose a danger. Yes, this can create problems of succession, but Wall Street dealt with it for a hundred years or so. These guys ought to be smart enough to figure it out.
I’d also have pretty draconian penalties for breaking the rules, the sort that can have individuals involved and their supervisors forfeit a lot of dough and go to jail.
Thus I’m not as pessimistic about the ability to leash and collar the industry, perhaps because I lived in it briefly when it was more heavily regulated and it functioned much better for society as a whole than it does now. And the bankers still made a very nice living, although nowhere near as egregious as the pay scales of late. The real constraint is political will, and I don’t think things have gotten bad enough yet for the public to demand an end to rule by finance. But that attitude will change if real estate prices fall another 10%.
Posted by: bmh | April 18th, 2008 at 11:10 am | Report this commentIMHO if the issue of one-sided gains is fixed it will go a long way to curbing irresponsible actions.
Willem said “…should require that the entire board and top management resign and leave without even a bronze handshake…” I would go further and say that the top management should also lose all pension and share benefits they have acquired. This should extend backwards so that any management who have left in the last year are also liable unless they have publicly “blown the whistle”.
$159m (Merrill Lynch), $30m+ (Citibank) payoffs don’t exactly encourage much restraint. RBS pushed ahead with it’s expensive bid for ABM. Credit Suisse reckon RBS has £32bn of credit market assets at risk of further writedowns. Will Fred Goodwin suffer? Would he have agreed all this if he had known his personal wealth was at stake?
In construction 112 firms are accused of a cartel. Again senior management MUST be held responsible.
Posted by: tonyw | April 18th, 2008 at 12:22 pm | Report this commentIt is: “quis custodiet ipsos custodes?” Otherwise, this is a very thoughtful piece. I am still musing on my own column on how to regulate better.
Posted by: Martin Wolf | April 18th, 2008 at 12:55 pm | Report this commentI’d argue that most of the problems emanate from the sell-side (i.e. banks). I’d also argue that the incentive structure at banks is all wrong. How many bank traders have 50-100% of their net worth invested in the bank? How many of them have high watermarks? etc.
Posted by: Anon | April 18th, 2008 at 1:16 pm | Report this commentBMH’s solution is far too logical and effective ever to be implemented. Pity!
But another partial solution to the regulatory question is to abandon the aim of being egalitarian. Regulators usually try to act equably to all firms of whatever size. In reality they usually end up being harsh on small firms and lax on larger ones. This needs to reverse.
If the regulators and the regulated both understood that the bigger a firm gets, the more control the regulators should have over it, this would provide an automatic brake on the excesses prof. Buiter points out so well.
Posted by: Anthony New | April 18th, 2008 at 1:26 pm | Report this commentAny of the big five or six Wall St. banks would have to undergo rigorous cross-examination on every new financial product, and to pay the regulators for this analysis and for a permit to use these.
Market freedom would be maintained because smaller firms would not have to undergo this tight regulation. This would provide an un-natural market force that counters the so-called economies of scale and helps small firms to operate against big ones. It also helps to curtail the enormous size of benefit packages that the stars of these mega-corporations receive, which one way or another the rest of us small fry have to pay.
A couple of years ago, FT contributor John Kay chipped in with more Latin: “Quis custodiet custodes?”. http://www.johnkay.com/regulation/442
In an article ‘Auditors need to escape the Prisoner’s Dilemma’, he concluded:
“Regulatory bodies must take responsibility not just for accounting standards, but for standards of accounting; and acquire powers of inspection that are not dependent on complaint and in which the fact of investigation carries no stigma. The purpose is not to name and shame delinquents, but to give auditors backbone to resist pressure from their clients and to restore the ethos that has been undermined as accounting has shifted from liberal profession to competitive business.”
Posted by: Slightly Optimistic | April 18th, 2008 at 3:10 pm | Report this commentFinancial Integrity is a public good. Buiter’s sensibility regarding the myriad of externalities and market imperfections appears to be a clear description of the context of financial markets imbedded in a social system.
Many of the suggestions for reducing balance sheet complexity and excessive leverage are conceptually viable. The anxiety that complex instruments have generated in the realm of counter party risk in the current episode shows that the clarity of the financial intermediation process is of value to society. The 30 to 1 leverage ratios cannot now sustain the risk premiums that have infected funding costs. Those leverage ratios appear to have been aided and abetted by the skew in compensation schedules that the promise of state support creates.
Dr. Buiter’s concerns about regulatory integrity are a wonderful addition to our awareness of the true nature of the challenge of social design and implementation. He appears to emphasis the use of rules more than the discretion of regulators. The logic of that seems very strong. Yet, at least in the USA, that raises further problems as the rule makers are paid by the Wall Street leaders through endless political fundraisers. Senate and House leaders of both parties want a war chest to win the control of Congress. Given their goals they are unlikely to set rules that bite the hand that feeds them.
Will we ever be able to recognize, honor and implement rules designed from the perspective that financial institutions are “wards of the state”(BMH above) in the USA?
Listen to Wall Street oracles espouse the virtues of free trade, the role of the dollar as world currency and NYC as the financial center. Even their own cherished goals have been thrown in the fire by their compulsive behavior. If their own goals cannot be guarded by self interest we are right to ask whether they can be trusted to self regulate or advise and direct the rule making process as they do now with their wealth. There is one too many markets in America. The market for the rules of the game does itself needs rules to generate a rule making process that does not so badly refract our social goals.
Deference to the intimidation of expertise and complexity has been the American way of handling these challenges. Too difficult for the people to grasp is the justification. That notion may or may not be right. Even if it is, it runs the same risk of capture as Buiter describes for ambitious regulators. Economists and experts are themselves subject to the same forces relating to desired prestige and compensation. A messy human process indeed.
Posted by: Robert Johnson | April 18th, 2008 at 3:43 pm | Report this commentThe Latin is from the Roman poet Juvenal and is, indeed, “quis custodiet ipsos custodes?” The dilemma of regulation is not a new one. Government is both inevitable and ineffective. We need to strike a balance. The aim, in my view, is to impose simple and measurable requirements that create the right incentives for the players.
Posted by: Martin Wolf | April 18th, 2008 at 6:16 pm | Report this commentRe: ‘custodes’ rather than ‘custodienses’. Ouch! Thanks. Now corrected. There are two lessons for me here. First, don’t try to show off unless you are sure your slip won’t be showing. Second, get a Latin spellchecker.
Posted by: Willem Buiter | April 18th, 2008 at 7:13 pm | Report this commentMartin, I am looking forward to a column by you which will address the questions Prof Buiter has raised and expand on what you have posted above.
As for the Latin: I was wondering if Prof Buiter’s rendition could possibly be correct. My one argument in favour was that Prof Buiter would know you were watching and would therefore check before committing. In the event, it seems this has become one more example of regulatory failure!
Posted by: Ron Cohen-Seban | April 18th, 2008 at 7:57 pm | Report this commentYou people are literally f***ed.
The ‘cradle to grave’ mentality is offensive in the US. We in the US are anarchists at heart, because we know that we can do it ourselves, and we do. No help from a tit-sucking government. The less government, the better. Small government and market freedom is key.
Discuss your horse s**t academic thoughts all you want. The bottom line is freedom. FREEDOM. ECONOMIC FREEDOM!
Posted by: Patrick Hobbs - American Libertarian | April 19th, 2008 at 12:20 am | Report this comment[…] Buiter writes a gloomy piece on financial activity, If it’s broke, fix it, but how?. Hat tip to Naked Capitalism, who commented on the piece … but quite frankly, NC’s […]
Posted by: PrefBlog » Blog Archive » April 18, 2008 | April 19th, 2008 at 1:09 am | Report this commentIts really all about accountability and transparency isn’t it?
Accountability meaning responsibility for the assets used and results achieved. Hence the objections to the banks speculating with the public’s money, before or after the fact.
Transparency is the great tonic of the financial markets; the even dispensing of information in an open and time even basis.
Much of what we have seen in the crisis so far has come from the repeal of Glass-Steagall and the mingling of public monies and implicit government guarantees, and the outrageous maneuvering and insider sharing of information that has become the cornerstone of the US markets.
If the big trading banks get waves of nausea and fall into fits of vitriol about the transparency of information and positions, then we’ll know we’ve struck the root, and stopped merely slashing at the branches.
Posted by: Jesse | April 19th, 2008 at 2:36 am | Report this commentIt really comes back to what sort of markets we wish to have, doesn’t it?
Do we wish to have reasonably efficient markets with rational price discovery, and a capital allocation model that helps to support and evolve the real economy?
Or do we wish to have markets overburdened with internally focused ‘bets’ having little or nothing to do with the means of production and the allocation of capital, an shadow banking system as Dr. Michael Greenberger describes it, that tends to bend the real economy to its own needs, ultimately misallocating wealth so badly as to kill off the middle class and bringing the nation to the verge of political crisis?
We’ve been there before, there is no reason why it can’t all happen again. But you will not get the people to intiate the remedy. But they will accept it as proposed if we stop trying to play them the fools.
Posted by: Jesse | April 19th, 2008 at 3:01 am | Report this commentNot to belabor this, but it really comes back to what sort of markets we wish to have, what we think we need, doesn’t it? Just as what sort of schools and neighborhoods we’d like to maintain.
Do we wish to have reasonably efficient markets with rational price discovery, and a capital allocation model that helps to support and evolve the real economy?
Or do we wish to have markets overburdened with internally focused ‘bets’ having little or nothing to do with the means of production and the allocation of capital, an shadow banking system as Dr. Michael Greenberger describes it, that tends to bend the real economy to its own needs, ultimately misallocating wealth so badly as to kill off the middle class and bringing the nation to the verge of political crisis?
We’ve been there before, there is no reason why it can’t all happen again. But you will not get the people to intiate the remedy. But they will accept it as proposed if we stop trying to play them the fools.
Posted by: Jesse | April 19th, 2008 at 3:02 am | Report this commentI agree with the Libertarian on a few points.
Posted by: joebhed | April 19th, 2008 at 2:40 pm | Report this commentEconomic freedom is what we should all be about.
Let the bankers play with their own money, and then let them have at it.
Freedom to win or lose each other’s real money.
If people want to make deposits in laissez-faire, risk-taking financial ventures, then let them.
Economic freedom.
With my economic freedom I would go join a credit union, newly enfranchised in the post-apocalyptic financial structure.
I will use my economic freedom to promote cooperative economics, and build a better world.
I wholeheartedly commend Buiter’s recognition, nay admission, that there is no transferable historic fix to the current imbroglio.
In doing so, there appears to be recognition that the future system of the house-of-finance will require new strengths and new protections.
As said Yves.
This is where I differentiate from the Libertarian philosphy.
I believe another scribe mentioned Madison’s philosophy on money matters, more akin to mine.
The power to create new money should be taken from the private bankers and restored to the government of the people in this country.
To me, that is what sovereignty is all about.
Let all of the cooperative people in the world have access to government-issued debt-free money.
At the same time, let all of the fiercely competitive, risk-taking capitalists get out there and tear each other up.
After all, it’s their money.
Yeah, libertarian….FREE BANKING!!!
Posted by: Gary Snecker | April 19th, 2008 at 5:38 pm | Report this commentI would love to see a discussion based upon all of the knowledge on this subject already learned through experience prior to the FDR which provided the logic for his successful programs.
Posted by: jdboise | April 20th, 2008 at 3:06 am | Report this commentChildren, having known little experience, may be convinced to believe in free-for-all based nations.
It seems clear to my mind that most of the above comments, except one that referred to “jail time”, have been written by children who have somehow learned how to write quite well…children in or close to the “club” who talk like they are long past due for a good thrashing. Sorry.
It was always and will always be about trust and integrity.
Don’t you remember how Tit for tat works? Tit for tat tracks reputation.
The solution was never to regulate institutions more, the solution is to track the career work/ethos of every individual in the system and forever share this information with everyone else (much like consumers want data on their physicians).
People have a way of cleaning up their own act if they realize their own personal reputation will be on the hook forever.
Posted by: Thai | April 20th, 2008 at 2:30 pm | Report this commentOn custodes, while Willem was becoming a well-trained economist, I was studying classics at Oxford. Occasionally, this has its uses.
To American Libertarian, you may well believe the US is a country of economic freedom. I lived in the US for a decade and learned to appreciate that it is a country of rampant regulation. The disjunction between how Americans think the US runs and how it does run is extraordinary.
Posted by: Martin Wolf | April 20th, 2008 at 6:29 pm | Report this commentYou need countervailing forces. Try this suggestion of mine below, to guard the guardians or regulate the regulators…
The AUCONTRAIRES could do it:
Many FT correspondents seem to think that better regulatory codes and higher quality regulation and regulators will suffice. Yet even improved regulatory systems will not, by themselves, be adequate. Something else is needed.
Over time, all human systems inevitably become complacent - or are deliberately sidestepped or undermined. They reach an inefficient equilibrium in their operations which is not fit for their original purpose. The prevention of future disturbances, which typically have escaped and disrupted current or previous regulatory systems, clearly requires a new approach.
LEX, in his column of March 28, recognised that contrarian thinking and input was necessary, together with toughness amd agility. However such alternative visionary thinking, that clashes with present incumbents, is never welcome as Mr Raja Iyer’s letter to the Editor of March 29 made clear.
What has not been recognised previously is that competing regulatory forces are needed to try to maintain ongoing regulatory relevance by ensuring timely adaptation. If competition creates problems, it can also resolve them.
It is only by introducing alternative thinking into the system, as a check and balance to the increasingly complacent regulation that always occurs in human systems as time passes, that we stand a chance of minimising future breakdowns and can therefore hope to lessen or avoid the pain and disruption that they cause. To be of use, this alternative thinking and point of view must be designed from the start to have transformational potential - or nothing will change. This means that it must have the in-built ability to challenge the status quo and upset the powers that be. Hence it must be designed to be a check on and balance to any existing or proposed new Regulatory Systems. It must also be completely independent of them, or careers will suffer.
I believe that it is necessary for all regulatory authorities and states to encourage the introduction of permanent, newly-designed and well-staffed countervailing forces that are independent of government, political or institutional control yet legitimised and paid for by them. Rather akin to judges, universities, or state-funded independent media, these new forces represent potential new separations of informed power and will become a new influence in the world. For this reason they will have the authority needed for their alternative voices to be heard and their views absorbed into - or seen to be clashing with - the mainstreams of prevalent thought, regulation and action. I suggest we call the units which provide these countervailing forces AUCONTRAIRES.
The task of each AUCONTRAIRE is to use its analytical prowess to forge, amplify and broadcast new strands of creative option-generation, knowledge and enquiry, so as to inject a variety of alternative viewpoints into regulatory perspectives, unthinking sentiments and market responses well before emotion defeats reason and causes system breakdown. My proposal is a way of avoiding complacency and challenging harmful bandwagon effects by forcing continuous appraisal of present approaches and sentiments. It should act as a damper on excess and a shock-absorber for the system. This task is well worth being paid for by the state. The irony is that it is the powers that be who must fund it if they are to lessen their future embarrassment.
It is probably better to try to dampen the investment enthusiasm that results from fast-flowing streams of confidence, well before irrational exuberance and high animal spirits make the flow a raging torrent, which overwhelms the regulatory forces that were supposed to prevent such destabilisation from occurring in the first place. Reason, not sentiment, must be made to rule. This suggestion is not presently intended as a replacement for current, modified or new regulatory systems; nor is it mandatory for any AUCONTRAIRE’s views to have to be listened to. Rather, they are an evolutionary, systemic adjunct designed to compete with regulation as usual. Their purpose is to be an authorative, well-reported source of alternative points of view and analysis. This contrarian eclecticism will hopefully encourage other doubters to voice their concerns too, so that the whole system becomes more thoughtful and responsive.
Each AUCONTRAIRE acts as a counterpoint to prevailing fashions and opinions. It is charged with the continuous generation, amplification and broadcasting of contrary winds of opinion. The presence of robust clashing views should help to turn the tide of excessive optimism sooner, before much damage is done. It should stop the herd acceptance of the runaway majority viewpoint by providing the critical thinking and reflection that is needed as a counterpoint to the prevailing fashion that always prevents adequate analysis.
The AUCONTRAIRES’ role is to generate a variety of unfamiliar new ways of explaining what is, or might be, going on. By their very nature, they do this in ways that raises doubts about the certainty of current trends, principles and practices. To sustain this abrasive edge, their staff should be on short-term contracts, sabbaticals and secondments, so that their views, in turn, do not ossify.
Norman Strauss
Posted by: Norman Strauss | April 20th, 2008 at 10:15 pm | Report this commentTo Martin Wolf. Good point about regulation in America, but there is nonetheless something exceptional about the US economy. I think it is related to what Barry Eichengreen identified in his recent book on the European Economy Since 1945, where he contrasted the centralised financial, regulatory and labor markets of Europe with the US and makes the point that, while central direction served to mobilize the European economy by coordianting actors and focusing resources on identified sectors, it did so at the cost of preventing Europe from developing an innovative economy. That has been left to the US, where decentralization (as opposed to laissez faire) has kept it at the head of the pack economically.
Regulation in the US tends to follow innovation, so it spreads to sectors only after they have developed and by then, at least over the pat century, there are new sectors being developed which add to productivity and generate employment. The openess of US capital markets are probably the most important catalyst for this process. I remeber reading an interview with Mr. Nixdorf in the 1990’s which he used Steve Jobs as an example of an entreprenuer who could not possibly find financial backing in Europe’s capital markets, as he lacked pedigree, dressed inappropriately, had the wrong political opinions,didn’t attend the proper schools etc…only in America could he launch Apple.
Posted by: Daniel J Aronoff | April 20th, 2008 at 11:28 pm | Report this commentThe truth but far from the whole truth!
This is a great article by William Buiter and he is right when he says “The key policy issues created by the recent excesses of the financial sector, once the immediate financial crisis has been euthanised, are those of governance and regulation.”…but only if we were on the finishing stretch of our thinking process.
Unfortunately, before we get down to work on governance and regulation perhaps we should better take a bigger step back and think again about the whole purpose of the financial system.
The only firm objective for our financial system currently defined by the financial regulators and most specifically the bank regulators anchored on Basle is that their members should not default… and to me that sounds like the most purposeless objective ever. Do we not want more from our financial system?
A young entrepreneur with good ideas and lots of initiative but no financial backing will always find it more difficult o borrow money than someone who just wants to anticipate some of his consumption and has good earning prospects or other assets to guarantee his borrowing with. That is the market price for risk.
But, today, on top of that market premium for risk, as if it was not enough, our bank regulators have introduced an additional tax on risk, a regulatory risk adverseness tax.
This has been done through the minimum capital requirements for banks and that are based solely on the risks of default as measured by the credit rating agencies.
As risk is the oxygen of any development this is plain crazy, and so if we really want to start thinking again about a financial sector that produces more real sustainable results than the last western world growth cycle has to show for itself, we need to start thinking of risk more in terms of an element to be consumed in order to produce some other results than pure short-term profitability, like for instance units of risk of default per decent job created, per person educated or per environmental hazard avoided.
In order to do that though, we need to break the regulatory stronghold that those very single-minded and default risk obsessed Basel regulators have on the process.
The risk of bank defaults and bank crisis is a minor risk when compared to the financial sector not doing its job!
http://teawithft.blogspot.com/
Posted by: Per Kurowski | April 21st, 2008 at 12:39 pm | Report this commentThe AUCONTRAIRES suggested by Norman Strauss above could perhaps come to the conclusion that there is nothing as risky as fully successful regulators, in their endeavors to eliminate risk.
Posted by: Per Kurowski | April 22nd, 2008 at 2:23 pm | Report this comment