I can see that there is going to be a lot of debate over the next year (until the day after the US Presidential elections, anyway) about regulation, so I’ve started a new category in this blog for it.
Anyway … the forces of regulation are gathering and the issues need to be understood.
Menzie Chinn at Econbrowser abandons her usual highly technical approach to state:
While I haven’t drawn a particular conclusion regarding the right direction to move, one insight prompted by current commentary is that — if the Fed were to opt for looser monetary policy — greater regulation of the financial sector would make a lot of sense.
I don’t know. To me, that if-then logic looks like a complete non-sequiter, but I can’t really comment too much until there is something to comment about. Let’s hear some proposals – I’ll consider them!
Mark Thoma has written a piece titled Fed Intervention and Moral Hazard which, really, simply explains the concept of moral hazard in home-spun tones, but declares himself “in substantive agreement” with what must be deemed a polemic by Robert Reich, Stop the Hedge Fund Casinos:
Yet there’s precedent: in September 1998, despite growing evidence of inflation, the Fed lowered interest rates in order to forestall a global credit crisis after Russia defaulted on its loans (many had been underwritten, foolishly, by several large Wall Street investment banks).
No substantiation is offered for the word “foolishly”. Additionally, there is no acknowledgement of any role played by investors, as opposed to underwriters, in the process.
Oddly, private credit-rating agencies judged these “sub-prime” loans to be relatively good risks.
Mr. Reich does not substantiate his use of the word “Oddly”. Additionally, there is no indication of an awareness of a risk/return trade-off.
Meanwhile, hedge funds created what can only be described as giant betting pools — huge amalgamations of money from pension funds, university endowments, rich individuals, and corporations — whose assumptions about risk were derived from the assumed low risks of the home loans (hence the term “derivatives”).
This is a novel derivation of the word “derivatives”! One can, I suppose, characterize hedge funds as giant betting pools – but only to the extent that any investment that has ever been made in the history of the earth has been a bet.
Investors in these hedge funds had little or no understanding of what they were buying, because hedge funds don’t have to disclose much of anything.
No substantiation is offered for this rather surprising smear. In the first place, the fact that hedge funds don’t have to disclose much of anything to regulators doesn’t mean they don’t disclose anything to investors. It is up to investors to demand whatever they want to demand from those who want discretionary authority over their money – Mr. Reich does not make any sort of case that further disclosure to regulators is necessary.
An investor can do whatever he wants with his own money. If, however, someone is acting as a fiduciary (as will be the case with pension funds and university endowments) there is a standard of care required. There may well be cases in which the Prudent Man Rule has been violated – well, nail ’em to the wall, I say, and I’ll ask Mr. Reich to pass me the hammer; that is not only a separate issue, but it’s already regulated.
That doesn’t mean, though, that the irresponsibilities now so clearly revealed in American financial markets should be excused or forgotten.
Mr. Reich forgets that he has not, in fact, discussed even a single instance of irresponsibility.
Credit-rating agencies have cut corners or averted their eyes, unwilling to require the proof they need.
This is the first mention of credit-rating agencies in the entire essay. No supporting evidence or argument is brought forward to support this charge.
They’ve [the credit rating agencies] been too eager to make money off underwriting the new loans and other financial gimmicks on which they’re supposed to be objective judges.
I am not aware that any credit rating agency anywhere has acted as underwriter. I’m not even aware of any credit rating agency having a license to underwrite. Let’s have a few more details, Mr. Reich!
Banks and other mortgage lenders have been allowed to strong-arm people into taking on financial obligations they have no business taking on.
Strong arm? Let’s have some evidence, or some argument at the very least. I suspect that any wrong-doing of this nature is already regulated.
For the financial market to work well — to ensure fair dealing and to prevent speculative excess — government must oversee it.
There are no arguments, no details and no evidence in this essay to make this assertion even worthy of consideration.
This mess occurred because nobody was watching.
Nonsense. There ain’t nuthin’, anywhere on earth, watched as carefully as the financial markets. Investors, traders and Mr. Reich’s beloved regulators watch it very carefully indeed.
Credit-rating agencies must not have any relationship with underwriters.
What? They shouldn’t even accept details of the issue so they can assign a provisional rating prior to its sale to investors? Mr. Reich betrays complete ignorance of the credit rating process with this slogan.
Finance is too important to be left to the speculators.
I’m … speechless.
[…] Loyal readers will know that I’ve become sufficiently irritated by calls for increased regulation to write a post on the topic (well, it’s really just a commentary on another essay) and even to initiate a category for what promises to be a series of posts. I don’t think the issue is going to go away any time soon … the New York Times has published an article with many interesting statements: “In a globalized economy with hedge funds, leveraged buyouts and all these investment funds, we have to ask the question about more transparency,” said Claude Bébéar, the chairman of the supervisory board of the insurance company AXA […]