Saturday, November 1, 2008

More on The Financial Mess

So I posted a while back on how despite all the political rhetoric and anti-business bashing going on, that our current economic woes were not simply due to "greed" but rather in large part due to a set of polices that changed market incentives. I talked relatively in depth about the role that monetary policy had in creating the housing asset bubble.

So, here is an article that I would not have been surprised to have found on the editorial page of the Wall Street Journal, but was completely shocked to find it in the Washington Post. Apparently even their editorial board, not normally a bastion of free market thinking, agrees with this premise and is attributing much of the blame to poor governmental market intervention.

...the problem with the U.S. economy, more than lack of regulation, has been government's failure to control systemic risks that government itself helped to create. We are not witnessing a crisis of the free market but a crisis of distorted markets.
Though I don't agree with its entirety, the article is a good brief overview. I found the comparison to Canada, which I was not familiar with, particularly interesting.



Since the early days of the crash, EJB and I have discussed the matter of blame extensively - via phone, email, text message, pony express and even carrier pigeon. He has done much to convince me that the free market was not entirely to blame and that, in fact, private entities were simply taking advantage of a system which incentivized their risky behavior. Of course, it goes without saying that in events like these, it is impossible to blame any one factor entirely. There were multiple causes, with varying degrees of blameworthiness.

To that end, I point you, the reader, to the blog of one of my favorite people in the world - Richard Posner. I don't always agree with Judge Posner - especially with his attempt to analyze the tort system in purely economic terms - but he has a theory of what happened during the crash that deserves some consideration. The article is essentially Posner's attempt to explain why the warning signs of the crash were ignored or misunderstood. The crux of his argument is this:

Which brings me to the last and most important reason for the neglect of the warning signs, because it suggests the possibility of responding in timely fashion to future risks of financial disaster. That is the absence of a machinery (other than the market itself) for aggregating and analyzing information bearing on large-scale economic risk. Little bits of knowledge about the shakiness of the U.S. and global financial systems were widely dispersed among the staffs of banks and other financial institutions and of regulatory bodies, and among academic economists, financial consultants, accountants, actuaries, rating agencies, and business journalists. But there was no financial counterpart to the CIA to aggregate and analyze the information--to assemble a meaningful mosaic from the scattered pieces. Much of the relevant information was proprietary, and even regulatory agencies lacked access to it. Companies do not like to broadcast bad news, and speculators planning to sell a company's stock short do not announce their intentions, as that would drive the stock price down, prematurely from their standpoint.
Sort of like EJB being surprised to see a free market defense in the Washington Post...I'm utterly shocked to see this argument put forward by the creator of the law and economics movement. But, when one carefully examines the argument, one realizes that Posner is not advocating for government regulation - he is advocating for government oversight. This, I think, is a key difference that has been conflated by the media. Like Posner says, there is no agency that could "aggregate and analyze" scattered pieces of market information. These are important words - aggregating and analyzing information does not include the creation of rules and laws that would constitute regulation. It simply means, there ought to be an agency that gathers information already available to the public, which that agency could then analyze to discover what types of risk or how much risk any given market is prone to. Posner calls this the most important reason for the failure to detect the impending crash and I completely agree. The SEC does not fulfill this important role. A new agency must be created - one which cannot issue regulatory rules, but can only compile and analyze global market information. It should perform a risk assessment function and report its findings to the relevant authorities. Posner, I think you nailed this one.