A Sad, Sorry Song

by Thomas McQuade

In looking back over the many excellent posts and comments that have graced ThinkMarkets in its first year, I was struck by the fact that, while many of the literary virtues have been displayed, there has been – surprisingly – nothing that could pass as poetry.  I hope to be forgiven the presumption of attempting to rectify that omission with the following submission, vile doggerel though it may be.

I have a tale to tell, O!  (A sad, sorry tale, O!) …
It is told in the hope there’s no slipp’ry slope
And that prudence can prevail, O!
Tells the cause of a crisis, cruelly cast
Hitting hard-won savings, thought amassed.
It involves good intentions gone astray,
And the misplaced myth that some experts may
By their brains and their brilliance brave the way
To ensure economic ease, O!

Big Bad Bank and Little Red Trustbuster

by Chidem Kurdas

A surprising new Small-Is-Beautiful movement is afoot.  Mario Rizzo, Jerry O’Driscoll, Harry Kaufman and others make a case for  breaking up too-big-to-fail financial institutions. As Mr. Kaufman puts it, otherwise those companies will become financial public utilities backstopped by the government.

It’s not likely that the 2008 crisis would have been prevented had top investment banks like Goldman Sachs been smaller. Traditional little banks are going down in droves. They fail because real estate loans are going bad. So many depository banks have gone under that the FDIC, the federal agency that insures deposits, itself ran out of money and asked to be bailed out by prepayment of bank premiums.

The same real estate bubble-and-bust hit larger banks through mortgage-backed securities. That’s regardless of size. Moreover, the government does not just bail out big investment banks. It bailed plenty of small savings & loan associations in the 1980s. The concept of “too-big-to-fail” is remarkably elastic.  Consider that GM and Chrysler both received federal aid. Chrysler is a lot smaller, but the political preference is to treat it as too-big-to-fail. Keeping banks relatively small will not stop such bailouts.

That said, there is a serious quandary.

Regulatory War of Choice

by Chidem Kurdas

“A just war” is how Treasury Secretary Timothy Geithner describes the movement to expand financial regulation.  “It’s a war of necessity, not a war of choice,” he  is reported as saying about  the battle to impose greater government control on the financial sector.

This is the man who presided over the New York Federal Reserve Bank as the Fed assiduously provided the monetary fuel for the over-expansion of credit and the associated property bubble. The eventual implosion  of the twin bubbles caused the financial crisis of 2008.

For sure, markets are prone to ups and downs, because people are prone to behaviors like herding. And yes, bankers drank the spiked punch, as did myriad others from mortgage originators and real estate developers to over-extended households. But the Fed provided the heady stuff, thereby creating a boom-and-bust cycle of extraordinary magnitude.

Now, does Mr. Geithner’s proposed regulations seek to prevent similar nefarious policies in the future by limiting the Fed’s discretionary powers? Of course not. Silly even to ask. His quest is to expand the authority of government agencies, not to regulate them.

The one attempt to get a sense of what the Fed is up to, a bill by Congressman Ron Paul, has been destroyed at a Congressional sub-committee—even though it had 308 co-sponsors.

Too Big to Fail Red Herring

by Chidem Kurdas

The Obama administration has perfected the fine art of taking a real issue and using it to justify a policy that will almost certainly make the problem worse. Claim to control medical costs, add another trillion dollar medical entitlement to truly break the bank—that sort of thing. Looks like we have another example coming.

The Treasury and House Financial Services chief Barney Frank are apparently cooking up legislation that will allow the government to wreck havoc with the creditors of large financial companies. This is in the name of imposing “market discipline” on institutions that may have to be rescued because they could endanger the system.

“The measure would make it easier for the government to seize control of troubled financial institutions, throw out management, wipe out the shareholders and change the terms of existing loans held by the institution,” according to the New York Times report.

Scroll back to September 2008. Lehman Brothers files for bankruptcy, the credit market seizes up and stocks tank. What difference would the proposed law make in that situation? Lehman management is out and shareholders are wiped out anyway. Instead of regular bankruptcy, where the creditors exert influence, government directly takes over.

So the difference is that lenders will no longer be able to enforce their contractual claims. Oh yes, that will  be just the right remedy for a fragile credit market. You’ll tell lenders they’re toast! That will really get credit flowing.

Don Boudreaux’s WSJ article on “insider trading”

by Sandy Ikeda

Congratulations to Don Boudreaux for his article debunking insider-trading regulations, “Learning to love insider trading,” which covers the entire front page of the Weekend Journal section of this morning’s paper.

Prohibitions on insider trading prevent the market from adjusting as quickly as possible to changes in the demand for, and supply of, corporate assets. The result is prices that lie. And when prices lie, market participants are misled into behaving in ways that harm not only themselves but also the economy writ large.

With last week’s arrest of Galleon hedge-fund founder Raj Rajaratnam, insider trading has been very much in the news.  And now Don has done an excellent job of using and extending arguments originating with Henry Manne to help us understand just what is and isn’t at stake.

Goldman Critics vs. Little Goldmans

by Chidem Kurdas

Goldman Sachs has become exhibit number one in attacks on Wall Street and capitalist greed. Last week’s announcement that the bank had strong third-quarter earnings and is on track to pay big bonuses added to the media feeding frenzy.

Let’s look at the logic – to the extent there is logic – in the mass fury.  The assault on Goldman contains at least three, related but distinct, complaints.

• The bank’s profits are not just obscene but the result of reckless bets. “Goldman is back to business as usual: making money by high-risk gambling,” writes Frank Rich in the NYT, to pick one out of a herd of writers sounding the same theme.

Fast Track To The Single Payer

by Mario Rizzo  

For some time I have been interested in the dynamics of public policy – specifically, how particular policies make further policies more likely. Glen Whitman and I explored this in general terms in our paper, “The Camel’s Nose is in the Tent”  and our own Sandy Ikeda’s book, The Dynamics of Interventionism offers a different, but largely compatible, general dynamic framework  

I believe that dynamic-tendency (or slippery-slope) analysis — if carried on in a coherent theoretical framework with plausible empirical assumptions — can be a powerful supplementary critique of public policy.

The healthcare area seems especially prone to the dynamics of the slippery slope. In this post I wish to point to several factors that will ensure that the current proposals, if adopted, will not constitute a policy-equilibrium. Thus, they will likely lead to more and worse intervention by the state. 

Frank and Stein

by Thomas McQuade  

In a recent opinion piece in The New York Times (“The Invisible Hand, Trumped by Darwin?”), Robert H. Frank proposes that Charles Darwin, not Adam Smith, should be seen as the real intellectual founder of the discipline of economics.  He claims that Smith’s most famous idea – that the competitive pursuit of individual self-interest can redound to social good – is but a special case of Darwin’s more general picture of competition in which individual benefit sometimes does, but often does not, benefit the larger group.  The sort of competition for which the invisible hand does not work well is, he says, where the competition is for relative gain, i.e., when the rewards depend on relative performance, and people gain by bettering each other rather than by bettering nature.  

The problem with Frank’s argument is his careless deployment of the analogy between human beings interacting in a highly structured social environment and animals in general interacting in an environment of considerably less social complexity. 

Market Regulation

by Jerry O’Driscoll  

Benjamin M. Friedman wrote a review essay for the New York Review of Books on the crisis of the economy and the economics profession.   In an otherwise very good piece, he took an obligatory swipe at deregulators: “There is a long arc from Roosevelt’s acceptance of a useful role for government institutions and government regulation to the conviction of Reagan and Thatcher that the government is never the solution but actually the problem” (p. 43).  That is a straw man all around, but one promoted by textbook presentation of markets and the equilibrating role of prices.  

Regulatory Rabbit

by Chidem Kurdas

The official, semi-official and anonymous voices collectively known as Washington have spread the word for months that new financial regulation is coming. Now, we’re told the first draft will arrive shortly, but there are questions such as who will receive new powers and which bureaucracies will be merged.

One question that gets minimal attention is why the existing agencies with wide-ranging powers did not prevent banks from taking excessive risk, the behavior widely blamed for causing the credit bubble and subsequent collapse. That’s the crux of the regulatory issue, but Washington has already waved it aside.

A common excuse is that the financial system became too complicated for regulators, which lacked the expertise and manpower to deal with Wall Street’s newfangled notions. If that was the case, then the particular bureaucracies that did not supervise Wall Street should have performed well.