Competing Views on Regulation

From Joseph Stiglitz:

This is not the first crisis in our financial system, not the first time that those who believe in free and unregulated markets have come running to the government for bail-outs. There is a pattern here, one that suggests deep systemic problems -- and a variety of solutions:

1. We need first to correct incentives for executives, reducing the scope for conflicts of interest and improving shareholder information about dilution in share value as a result of stock options. We should mitigate the incentives for excessive risk-taking and the short-term focus that has so long prevailed, for instance, by requiring bonuses to be paid on the basis of, say, five-year returns, rather than annual returns.

2. Secondly, we need to create a financial product safety commission, to make sure that products bought and sold by banks, pension funds, etc. are safe for "human consumption." Consenting adults should be given great freedom to do whatever they want, but that does not mean they should gamble with other people's money. Some may worry that this may stifle innovation. But that may be a good thing considering the kind of innovation we had -- attempting to subvert accounting and regulations. What we need is more innovation addressing the needs of ordinary Americans, so they can stay in their homes when economic conditions change.

3. We need to create a financial systems stability commission to take an overview of the entire financial system, recognizing the interrelations among the various parts, and to prevent the excessive systemic leveraging that we have just experienced.

4. We need to impose other regulations to improve the safety and soundness of our financial system, such as "speed bumps" to limit borrowing. Historically, rapid expansion of lending has been responsible for a large fraction of crises and this crisis is no exception.

5. We need better consumer protection laws, including laws that prevent predatory lending.

6. We need better competition laws. The financial institutions have been able to prey on consumers through credit cards partly because of the absence of competition. But even more importantly, we should not be in situations where a firm is "too big to fail." If it is that big, it should be broken up.

From Tyler Cowen:

THERE is a misconception that President Bush’s years in office have been characterized by a hands-off approach to regulation. In large part, this myth stems from the rhetoric of the president and his appointees, who have emphasized the costly burdens that regulation places on business.

But the reality has been very different: continuing heavy regulation, with a growing loss of accountability and effectiveness. That’s dysfunctional governance, not laissez-faire.

...

In the meantime, if you hear a call for more regulation, without a clear explanation of why regulation failed in the past, beware. The odds are that we’ll get additional regulation but with even less accountability and even less focus on solving our very real economic problems.

Comments

[Roger Koppl]

This would be a good moment to take another look as Hans Stoll's proposal for competing financial regulators.Hans R. Stoll's url: (http://www.owen.vanderbilt.edu/vanderbilt/About/faculty-research/f_profile.cfm?id=137)

His proposal is expressed in "Regulation of Financial Markets: A Focused Approach," Multinational Finance Journal 2, 2 (June, 1998) pp. 87 - 99.

A slightly revised version entitled "Regulation of Financial Markets: Toward a Focused Approach," appeared in Journal of Applied Corporate Finance 14, 4 (Winter 2002) pp 122-128.

That would be way better than letting Joseph Stiglitz decide how often bonuses should be paid, or appointing him the head of some "financial product safety commission" or, worse yet, a "financial systems stability commission." I don't think a Big Player is likely to add stability!

"Historically," Stiglitz says, "rapid expansion of lending has been responsible for a large fraction of crises and this crisis is no exception." And how often has such an expansion occurred without a rapid expansion of the monetary base?

[Steve Horwitz]

Roger's last question is one right one, as are the points Tyler raises about the problems with existing regulation. There's no doubt that we're in for some short-term pain as lots of errors get washed out, but, fwiw, I'm still of the belief that the fundamentals of the US economy remain solid and that we are in no way talking about a crisis like that of the late 20s/early 30s.

What concerns me most, as I'm currently teaching Higgs in American Economic History, is that perceptions of crisis will continue to call forth excessive governmental responses, from which we will never recover. I think we're already seeing that ratchet process start, unfortunately.

[John V]

What Stiglitz says in his opening remarks is there is no frustrating to hear from a serious economist:

"not the first time that those who believe in free and unregulated markets have come running to the government for bail-outs."

This type of statement drives me up a wall. He seeks to knock down the idea of free markets...not by showing how free markets failed but rather by insinuating that those who come for bail-outs believed in free markets.

Now, whether or not that is even true, I still don't see how such a statement is successful in any way in undermining a free market argument. In fact, it simply doesn't.

Stiglitz does this a lot.

[John V]

Roger's remarks touch on the one crucial spot of the unregulated market failure argument where people like Stiglitz and Krugman simply refuse to go.

Why? They never acknowledge effects on behavior that previous laws and regulations have on an ever changing landscape. It borders on coy and dishonest.

[Rafe Champion]

Surely people who think that the markets of the world were unfettered during the 1920s and early 1930s can believe anything!

Is anyone monitoring school courses and textbooks on that kind of content?