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Monday, December 21, 2009
I'm not one to regularly quote from the Washington Post, but it's good to break free from the usual sources every now and again, yes? So here it goes, a WaPo retrospective on the US Fed's shortcomings in the run-up to the recent financial crisis:
The Fed's failure to foresee the crisis or to require adequate safeguards happened in part because it did not understand the risks that banks were taking, according to documents and interviews with more than three dozen current and former government officials, bank executives and regulatory experts.
But exactly what kind of lessons are we learning from this crisis? It's very important that we learn the right ones. Even if we acknowledge that there was a collective cognitive failure on the part of our regulators, there are a couple of different ways to run with this.
If we're of the mindset that we should see bankers hanging from Blackfriars bridge, or have their heads on pikes or whatever, I don't think the discussion will go very far. Despite the obvious excesses of financial sector, I am still waiting for evidence that performance bonuses to Goldman Sachs employees has been the cause of our financial crisis.
But let's agree that the Fed F'd up. What should we do about this? One option is to use this argument to argue against the re-appointment of Ben Bernanke as Chairman because of his obvious failures to mitigate the crisis. While there is merit in digging up all the mistaken decisions by the Fed in the past decade, scapegoating will not address the problems of tomorrow. John Maynard Keynes is reported to have said: "When the facts change, I change my mind. What do you do, sir?" When the facts changed for Bernanke in late 2008, he also changed his mind. Although late to the party, the Fed's willingness to adapt to the crisis over the last 16 months has been a crucial part of slowing the economy's decline and stimulating what is, to date, modest signs of recovery. (I think Rory agrees) (wait, so does TIME)
But even if we accept that the Fed has learned from some of its past mistakes, this has not addressed the fundamental problem with financial regulation: the regulators don't have the capacity to know everything that's going on. They never will. The people who work at investment banks, hedge funds and the like are too smart and too motivated. There will always be loopholes, and those loopholes will be found. That said, it should still be possible to avoid the kind of crisis that we just experienced, with huge sums of money (your money, my money) being used to prop up the balance sheets of our financial giants. I see at least three possible avenues for the future:
First, concentrate the US regulatory system into fewer bodies. I couldn't find the organizational chart I wanted, but you can get a sense of it from this summary. Compared to many other industrialized countries, this is madness. Having one financial entity regulated by so many different government bodies will leave gaps in coverage. It's hard enough for one government entity to share information with itself - multiplying entities will multiply the problem.
But with a more concentrated financial regulator, the information-gathering problem will not disappear. This is why I find Paul Volcker's vision for the US banking sector to be persuasive. Since we cannot prevent financial innovations and we cannot expect our regulators to understand all the risks associated with them, we should at least prevent our "systemically important" financial institutions from playing with them. The risks and rewards should be realized by firms which are able to fail.
Third, let's beef up the regulatory standards for our core financial industries - the ones we can't afford to see fail. The Basel Committee on Banking Supervision recently released its list of five suggestions for doing just that. This is an excellent place to start the discussion, and efforts to coordination internationally will help address concerns about competitiveness.
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I think that it's crucially important to learn the right lessons from this financial crisis and avoid being side-tracked by the promise of a quick fix (think: banking bonus supertaxes or the Tobin tax). From where I'm sitting, one of those key lessons will focus on cognitive limitations - the limited ability of our government officials, regulators, banking execs and individual investors to understand complex realities of the markets they interact with. Once we accept this, we can begin to build buffers against the problems that will inevitably arise.
Now if you'll excuse me, in recognition of my own cognitive limitations, I have a stack of holiday reading to attend to.
