Thursday, March 27, 2008

Ten Days That Changed Capitalism

That's not my own hyperbole in the title of this post - that's the headline of a Page One article in the Wall Street Journal. The world is different now.
"The past ten days will be remembered as the time the U.S. government discarded a half-century of rules to save American financial capitalism from collapse."

It is different in ways that many people don't appreciate. "[the changes from the government] are shrouded in technicalities and buried in a pile of new acronyms."

The political implications are, to use an overused word, profound.

"A Republican Administration, not eager to be seen as the second coming of the Hoover administration, showed it no longer believes the market can sort out the mess."

This is a dramatic change in ideology. Conservatives argue that the market works best when it is regulated as little as possible. This mess has illustrated, very clearly, the limitations of that ideology. And it's only going to get worse. When will we know it's gotten worse? When the bill shows up. "The next step, if one proves necessary, is almost sure to require the explicit use of taxpayer money." How happy are Main Street Americans going to be about bailing out people on Wall Street? Not very. I'm not going to be thrilled about it, that's for sure.

That's the article on Page One: change is coming, get used to it. But one interesting effect of reading the Wall Street Journal is that you notice a strong divide between the reporting and the editorial pages. Sometimes it's an almost schizophrenic divide. Just a few pages behind the article articulating just exactly why and how the government intervened in the market is an Op-Ed piece challenging the need for new regulations. Allan Meltzer, a professor at Carnegie Mellon, lets us know that "Mistaken regulation contributed greatly to the current problems in financial markets." So apparently it wasn't investment bankers making bad decisions based on greed and an unclear comprehension of how much risk they were taking on. It was the government trying to regulate the markets. I was under the impression that establishing guidelines for behavior was the government's job. I was also under the impression that responsible citizens generally try to follow those guidelines. Not according to Prof. Meltzer: "The first principle of regulation is: Lawyers and and politicians write rules; and markets develop ways to circumvent these rules without violating them." So it's fine to violate the spirit of the law, as long as you're within the letter. This is sort of like Martin Luther King's doctrine of civil disobedience, but for yuppies instead of oppressed minorities - if you consider the law unjust, try to work around it. Ethics be damned, apparently.

I've worked for investment banks, and I can actually understand this point of view. Investment bankers are paid to be creative with finances, and that requires knowing where the lines are in the law. And who among us has not thot about just how fast you can drive above the speed limit without getting caught? But instead of being creative on the legal side, shouldn't the core principle of a business be figuring out how to deliver value for your client? I notice that JPMorgan was in a position to take advantage of Bear Stearns' mishaps. I'm fairly certain that's because JPMorgan understood that one purpose of the rules and regulations that structure our financial system is to protect people from themselves. Those laws exist because when people get themselves into trouble, they tend to get other people in trouble, too. That's also why we have laws against drunk driving.

What's particularly bizarre about this line of argument is what happens when you apply it to the world outside of Wall Street. Let's try this. Should we have laws against robbing banks? No, because robbers are constantly innovating, and we can't catch up with them. Maybe we shouldn't try. Or how about this: if you install a burglar alarm in your house, some thief is just going to figure out how to get around it. So don't even bother locking your doors!

Conservatives occasionally make a good argument for too much regulation having unintended consequences. But the solution is not to abandon the enterprise of regulating the financial system or to take the path of least resistance. Conservatives, I think, are getting desperate to protect their franchise before it becomes so invalidated that they lose elections. But it's not working, because reality is intruding. You can tell people are is this kind of trouble when their arguments are sloppy. Prof. Meltzer uses a couple of examples of the failure of regulation that I think fail to prove his case:

"Regulators did not see the chicanery at Enron. Nor did they prevent the dot-com bubble or the Latin American debt problems in the 1980s."

They didn't see the problems at Enron because Enron was engaged in criminal activity and hiding it from regulators. And the dot-com bubble was a normal market correction - too many people got too greedy, and did not exercise good judgment. That's unfortunate, but there was very little illegality. And I don't know enough about the Latin American debt problems in the 1980s to comment intelligently. But the point is that this is a red herring - these are not examples of failures of regulation.

Mr. Meltzer seems to think that those who took the risks should pay the price - enforcing the moral hazard. Let the government keep this system afloat, but don't save anyone's skin who doesn't deserve it. Let the idiots hang. It's a harsh perspective, but not unusual (and, for some, I'm sure, a nice revenge fantasy).

What I find bizarre is the idea that we shouldn't bother trying to learn the proper lessons from this so that we can prevent it from happening again. It will happen again, the good professor seems to be arguing, so what's the point of even trying? Because, Prof. Meltzer, trying to find the proper range of regulation to balance the disparate needs of society is the purpose of democracy.

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