Re-Regulate Financial Markets?--Posner's Comment

I no longer believe that deregulation has been a complete, an unqualified, success. As I indicated in my posting of last week, deregulation of the airline industry appears to be a factor in the serious deterioration of service, which I believe has imposed substantial costs on travelers, particularly but not only business travelers; and the partial deregulation of electricity supply may have been a factor in the western energy crisis of 2000 to 2001 and the ensuing Enron debacle. The deregulation of trucking, natural gas, and pipelines has, in contrast, probably been an unqualified success, and likewise the deregulation of the long-distance telecommunications and telecommunications terminal equipment markets, achieved by a combination of deregulatory moves by the Federal Communications Commission beginning in 1968 and the government antitrust suit that culminated in the breakup of AT&T in 1983. Although one must be tentative in evaluating current events, I suspect that the deregulation (though again partial) of banking has been a factor in the current credit crisis. The reason is related to Becker's very sensible suggestion that, given the moral hazard created by government bailouts of failing financial institutions, a tighter ceiling should be placed on the risks that banks are permitted to take. Because of federal deposit insurance, banks are able to borrow at low rates and depositors (the lenders) have no incentive to monitor what the banks do with their money. This encourages risk taking that is excessive from an overall social standpoint and was the major factor in the savings and loan collapse of the 1980s. Deregulation, by removing a variety of restrictions on permitted banking activities, has allowed commercial banks to engage in riskier activities than they previously had been allowed to engage in, such as investing in derivatives and in subprime mortgages, and thus deregulation helped to bring on the current credit crunch. At the same time, investment banks such as Bear Sterns have been allowed to engage in what is functionally commercial banking; their lenders do not have deposit insurance--but their lenders are banks that for the reason stated above are happy to make risky loans. The Federal Deposit Insurance Reform Act of 2005 required the FDIC to base deposit insurance premiums on an assessment of the riskiness of each banking institution, and last year the Commission issued regulations implementing the statutory directive. But, as far as I can judge, the risk-assessed premiums vary within a very narrow band and are not based on an in-depth assessment of the individual bank’s riskiness. Now it is tempting to think that deregulation has nothing to do with this, that the problem is that the banks mistakenly believed that their lending was not risky. I am skeptical. I do not think that bubbles are primarily due to avoidable error. I think they are due to inherent uncertainty about when the bubble will burst. You don't want to sell (or lend, in the case of banks) when the bubble is still growing, because then you may be leaving a lot of money on the table. There were warnings about an impending collapse of housing prices years ago, but anyone who heeded them lost a great deal of money before his ship came in. (Remember how Warren Buffett was criticized in the late 1990s for missing out on the high-tech stock boom.) I suspect that the commercial and investment banks and hedge funds were engaged in rational risk taking, but that (except in the case of the smaller hedge funds--the largest, judging from the bailout of Long-Term Capital Management in 1998, are also considered by federal regulators too large to be permitted to go broke) they took excessive risks because of the moral hazard created by deposit insurance and bailout prospects. Perhaps what the savings and loan and now the broader financial-industry crises reveal is the danger of partial deregulation. Full deregulation would entail eliminating both government deposit insurance (especially insurance that is not experience-rated or otherwise proportioned to risk) and bailouts. Partial deregulation can create the worst of all possible worlds, as the western energy crisis may also illustrate, by encouraging firms to take risks secure in the knowledge that the downside risk is truncated. There has I think been a tendency of recent Administrations, both Republican and Democratic but especially the former, not to take regulation very seriously. This tendency expresses itself in deep cuts in staff and in the appointment of regulatory administrators who are either political hacks or are ideologically opposed to regulation. (I have long thought it troublesome that Alan Greenspan was a follower of Ayn Rand.) This would be fine if zero regulation were the social desideratum, but it is not. The correct approach is to carve down regulation to the optimal level but then finance and staff and enforce the remaining regulatory duties competently and in good faith. Judging by the number of scandals in recent years involving the regulation of health, safety, and the environment, this is not being done. And to these examples should probably be added the weak regulation of questionable mortgage practices and of rating agencies' conflicts of interest and, more basically, a failure to appreciate the gravity of the moral hazard problem in the financial industry.

Comments

[Rahul S]

What about the Community Reinvestment Act of 93? This is part of the reason why we're in this mess. This act mandated that more poor individuals be given loans otherwise the banks would be threatened with lower CRA ratings. It'll be too long to explain my reasoning, but here's a decent article.

http://www2.nysun.com/article/74903?page_no=1

[Biloxi]

"...For over 500 years, Venetian traders and bankers dominated European commerce. At their peak, they had more than 3,300 merchant ships and 36,000 merchant marines. They forged long-lasting business relationships throughout the Mediterranean and beyond.

They built the first capitalist empire, and the evidence is everywhere:

Next to St. Mark’s Basilica, at the entrance to the Piazza San Marco, stands Palazzo Ducale, an enormous marble palace that was the home of the Doge, chief executive officer of the Venetian Republic, a veritable corporate conglomerate.

Its Gothic arches towering over the water are a vivid testimony to Venice’s wealth and prosperity in 14th, 15th and 16th centuries."

Guess what happened?

"...The Palazzo Ca’ d’Oro, built in the early 15th century and once covered entirely with gold ... the Fondaco dei Turchi, originally built in the 13th century ... or the Scuola Grande di San Rocco, a majestic school made entirely out of marble.

But as evidenced in Rodney Stark’s The Victory of Reason, these visually vivid vestiges of the past teach equally vivid lessons for the present:

Lesson #1
Don’t Underestimate the
Power of Accurate Numbers
To Help Build Wealth

Venetians invented, or at least greatly perfected, double-entry bookkeeping.

Mathematicians such as Leonardo Fibonacci introduced the Arabic concept of zero to Italian bookkeepers. They taught businessmen how to calculate profit margins, use interest rates and allocate costs.

As a result, Venetian traders were able to spot market trends sooner than virtually any others in the world, act quickly, and profit handsomely ­ year after year, century after century.

They witnessed the flow of woolen cloth from Northern Europe through their warehouses and launched Italy’s textile industries. They saw opportunities in glass, dyes, crystal, shoes, jewelry, leather, and optical products such as eyeglasses. They built great wealth.

And today, investors armed with accurate numbers can do the same, provided they identify the winning sectors, such as oil, precious metals and other natural resources ... or winning regions of the world, like East and South Asia.

Lesson #2
Corporate Might, Applied Wisely,
Can Enrich You ... But When Applied
Recklessly, Can Bankrupt You.

The Venetians were the first to create modern corporations, run by professional executives, distributing profits to shareholders and rewarding employees based on merit.

Venice’s vast international banking conglomerates, such as the Riccardi Company founded in the 1230s, established branches in Rome, Nimes, Bordeaux, Paris, Flanders, London, York and Dublin.

The world had never seen anything like it before. And it made Venetian merchants and investors rich beyond their wildest dreams."
Martin D. Weiss, Ph.D.

Honorable Posner, do you not perhaps have any notion that it's imperative to discontinue banks such as but not limited to, JPMorgan/Chase in the practices of posing as honest - call it like it is.

Double-entry bookkeeping was supposed to work like a Christian tool, to keep it more forthright and "honest measuring."

But when the banks can expand exponentially the credit, which is debt, and then treat it as though real money to be not only repaid but paid back with usury sums of interest beyond the wildest imagination. I know you are not dumb enough to think this is fair and balanced.

Be that as it may, bad enough indeed, the third-party loans provided -- by the "borrower/s" which come from the credit cards as well as the home loans -- to the Hedge Funds for trading in the global market means the homeowner does not lose their home but again, indeed, the homeowner is owed money for loaning (without knowledge or permission, 100% illegal) to the hedge fund industry.

Now explaining "modern" double-entry bookkeeping seemingly very well known to American Banks since Citi was set-up in Dubai, 1948, as the "model" for expediency but of course:

The bank's general ledger/s = asset and liability; asset = loan amount and debit = loan amount = no loan and/or no debt.

THEN the new entry of a "loan" is placed on yet another ledger as a "deposit" and then expanded exponentially for further debt/credit for the bank to loan.

This is what the banks in America did to those who LABOR for money. Yes, the banks loaned money they made-up out of thin air (as you already know) which is debt sold to the homeowner as credit. Real property asset trading is fixed to specific laws (as you know) and to not provide a NOTE for a real property is 100% illegal.

There are no notes. There can be no notes because notes must be secured to a DEBT. There is no debt since the debit/credit is 100% against the money laws (as you know).

I realize I'm wasting my time sending you this but my hope is, is that there may be enough people who read this to spread the word and that is the important piece.

All Americans deserve to keep their home since they're owed money from the third-party lending they provided WITHOUT FULL DISCLOSURE (which is 100% against the money law/s), and therefore were "partners" in hedge fund profits.

My how much is each American homeowner entitled to with trillions earned in the hedge fund mania?

America could be rich rather than sinking just like Venice - or see the light before it's too late.

How many homeowners could use that money they traded in the hedge fund industry to prepare for a world that is starving for resources?

Why are American "leaders" not educated about money?

We have our own home-grown American genius about it:

THE WEB OF DEBT by Ellen Hodgson-Brown, JD. Perhaps it is time she teaches all those who are in charge of saving our wealth how to. http://www.webofdebt.com

[neilehat]

Ahh... Greenspan as a Randite. That's choice and conjures up images I'd really rather not contemplate. But, since it has, three works of fiction (I'll leave that to the Randites to fill in the details) does not a philosophy make. Although, it has fooled large numbers. Rand or whatever her "nom de guerre/plume" was simply a member of the Russian Bourgeoisie who was forcibly ejected from her comfortable position by the Bolsheviks and forced to attend the University Petrograd. Needless to say, Randism is but a simple a reaction to some of the more radical interpretations of Social Democracy that was at the time rising in the world at the end of 19th Century.

As for the American Experience in regards to Social Democracy, it culminated in the New Deal and Global War. And in the end flowered into HUAC (House Committee on Un-American Activities). Out of which some of the great names of the 20th Century arose, like JFK, Bobby Kennedy (maybe even Ted), Richad Nixon, Joe McCarthy and many others. From this "ideological" stew has arisen the regulatory/anti-regulatory debate that has crippled the National Economy.

Meanwhile, over the last 150 years or so, the disciplines of Engineering and Mathematics have been quietly and slowly developing the discipline know as "Control Theory" which deals with explaining and controlling the behaivor and outcomes of complex dynamical systems. Without going into developing the details of the discipline, that would take a few years just to explain, there are basically six control strategies that can be applied dependant on the complexity and dynamic behaivor of the system under observation. These are:

1. Adaptive
2. Hierarchial
3. Intelligent
4. Optimal
5. Robust
6. Stochastic

As for their application to Economics and Economic Systems, perhaps the best is either, Optimal, Robust, or Stochastic or a synthesis of the three. The reason being, that they take into account the complexities, difference in operations of the system from the ideal model, optimazation of various "cost indexes".

The "regulatory/anti-regulatory debate" is anachronistic, dead and behind the times. Welcome to the "New Economics".

Remember, "The Revolution will NOT be televised"!

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