FT.com / Comment / Opinion - Ways to avoid another stampede

The Financial Times has a few tips on how to regulate the financial markets to counteract the more perverse incentives that exist.
FT.com / Comment / Opinion - Ways to avoid another stampede

These are welcomed, particularly the variable leverage ratio. But "financial innovation" is precisely learning how to get around these, and creating new rules are often only effective until the next GOP admnistration takes a chainsaw to them.

Consider the press conference held on June 3, 2003 — just about the time subprime lending was starting to go wild — to announce a new initiative aimed at reducing the regulatory burden on banks. Representatives of four of the five government agencies responsible for financial supervision used tree shears to attack a stack of paper representing bank regulations. The fifth representative, James Gilleran of the Office of Thrift Supervision, wielded a chainsaw.

There needs to be a breakthrough in the issue of moral hazard.

The hazardous and morally-challanged elephant

So the web is lit with talk of proposals for rescue packages, China, G20 meetings (both of them), a giant IMF, Bretton Woods II, etc. But nobody is addressing the cause of this and all the bubbles: moral hazard. The market has failures. Legislation and regulators must exist, but so far there has been very little mentioned about the droll issue of new regulatory tools and expanded powers of surveillance.

It feels nice to have hope that some huge bailout package (if you ignore the fact that you are paying for them) will swoop in and save the day. It is sexy, and it makes headlines. It is also necessary to minimize the current crisis. But if you want to look at the future, a new structure that works hand in hand with the market to create counter-bubbly incentives is required. If this is not given the importance it deserves, the next bubble will also take us by "surprise".

No one could've predicted that history would, and will repeat itself...

The hazards of Moral

A friend has just started an interesting blog about economics with a Latin American bent. He writes in Spanish but I can vouch for his curiosity, open mindedness, and great work habit. Watch for him. Una Mente en Interdependecia

He brings up the issue of moral hazard and what to do about it. Of course, this is a topic where the discussion can easily turn to philosophy, but it is still a topic we must tackle for every major crisis has included this component. Investors price risks according to the possibility of being bailed out. "Too big to fail" etc. See Enron, S&L crisis, and today.

I don't think there is a way around it without regulation. I think this is the largest failure of the markets (benefits accrue to individuals while losses are socialized) and the greatest argument for regulation. In this sense, the price of deregulation, and the benefits of proper rules and enforcement must be included in any talk about the market. There is no such thing about public/private divide. The public sector is an actor, via policy and regulation, in the private sector. And the private sector is a strong influence on the public sector (sometimes vie large crises).