Saturday, May 23, 2009

Regulation, regulation, regulation

Is the current mood towards greater state interventionism, in particular in the regulation of finance, justified? Well the New York Review of Books' symposium on the crisis contains the following exchange between Niall Ferguson and Bill Bradley, which counterposes two views on this. For me it ends 3-0 to Bradley:

N.F.: Well, I tell you what, I feel depressed after what I've heard tonight. We are now contemplating a massive expansion of the state to substitute for the private sector because that's the only thing Paul (Krugman) thinks will deliver growth. We're going to reregulate the markets, we're going to go back to those good old days. Where were you in the 1970s when all these wonderful regulations were in place? I don't remember that going too smoothly. But what else are we going to do? We're going to print money. Almost limitlessly we'll print money. That's going to be fine, too. And when we're done with that, we're going to raise taxes. What a fabulous package we have in store for us. You know, back in late 2007, I was asked what my big concern was, and I said, "My concern is that we're going to get the 1970s for fear of the 1930s." It's very easy to forget, in your iron indignation at the failure of the market, where the true mainsprings of economic growth lie. The lesson of economic history is very clear. Economic growth does not come from state-led infrastructure investment. It comes from technological innovation, and gains in productivity, and these things come from the private sector, not from the state.

B.B.: As we look at the future, we also have to look at the mistakes policymakers made in the last ten years. It's not news that people are greedy. But we made conscious decisions not to put limits on that natural human impulse. What were the mistakes? In 1999, we allowed investment banks, banks, insurance companies to combine: we eliminated the Glass-Steagall Act, which prohibited commercial banks from operating as investment banks. Why was Glass-Steagall put into law? Because the last time we didn't limit greed we got into trouble, the Great Depression.

The second mistake was in 1999, the explicit decision by the Clinton administration and Congress not to regulate derivatives, in particular credit default swaps. In 2002 they were worth $1 trillion and today they're worth $33 trillion, and that decision not to regulate derivatives created the following sequence: you have mortgages; then a thousand mortgages are packaged and sold as a mortgage-backed security; a thousand mortgage-backed securities are packaged and sold as a collateral debt obligation [CDOs]; then a thousand collateral debt obligations are packaged and sold as a CDO squared; and insuring each one of those bundles are credit default swaps, which are a part of that $33 trillion. And our government deliberately decided not to regulate this chain of investments.

One result was that the 374 people in the London office of AIG who were responsible for AIG derivatives destroyed a company that had 116,000 employees in 120 countries. Why? Because there was no regulation at all.

The third decision was in 2004. The SEC allowed banks to go from 10 to 1 leverage to 30 to 1 leverage. And guess what? Once they were allowed to do it, they did it. So if we're going to look at the future, we might think of undoing those three mistakes.


Bradley doesn't end with 'I rest my case', but I'm not sure how you can answer that.