Monday, August 10, 2009

Blog Battle Recap

My blog war with Justin Fox over at CBS Money Watch ended today. I'm still alive and not in a prison camp, so I guess I won! Actually, like most debates, I'm sure we merely comforted those who agreed with us (has a debate ever changed anyone's mind?). Here's my Cliff's Notes version of the debate:

Post 1 (Fox) . Fox comes in with modest critique that no one really disagrees with:
Lulled into the belief that financial markets knew best, the reasoning goes, investors and regulators failed to do anything to rein in an out-of-control housing market bubble-and now we’re all still suffering from the consequences.
I wouldn’t go quite that far.

Post 2 (me). Well, that leaves a lot of room, including many reasonable and unreasonable inferences. I try to hit at his insinuation that the housing crisis was caused by the market
In light of this governmental housing exuberance, I doubt that a more powerful government would have mitigated the boom — rather, it would have made this crisis worse. Indeed, it was only the collapse of the subprime market at the beginning of 2007 as reflected by the ABX-HE subprime housing index that alerted people to the severity of this problem, and shut off financing by mid-2007, six months later. Market prices, not legislators, instigated the end of the insanity. How quickly are failed governmental initiatives usually stopped, once identified?

Post 3 (Fox). He argues that some regulations probably help.
There’s a lot of appeal to the argument that reducing leverage should be the main priority, because a financial system built on debt is inevitably more fragile than one that is not. There are also lots of ways to get around and game leverage restrictions, though. In any case, just saying that markets are better decision makers than governments and leaving it at that isn’t very helpful.

Post 4 (me). I argue we don't need regulation, and most regulation is about stiffling competition, not helping consumers.
In the bad old days prior to much financial regulation, or even a central bank, we had crises every twenty years: in 1819, 1838, 1857, 1873, 1893, and 1907. After a couple of years, though, things always got better...Much regulation is really about preventing competition, under the guise of protecting a consumer from some wily salesman, so it becomes a sanctuary for scalawags. Because of regulation, Wal-Mart can’t offer most simple banking services

Post 5 (Fox). Markets need a little help.
the Basel II capital standards are an unholy mix of (a) the conviction that financial regulation is needed and (b) the belief that said regulation should rely on market prices and on risk formulas devised by finance professors and their ilk... We will have financial regulations. So they ought to take explicitly into account the reality that financial markets tend to overshoot.

Post 6 (me). We have a lot of data. In practice, regulation makes things worse most of the time.
Consider the economy as an ecosystem growing in an equilibrium designed by no single agent. If you try to make it ‘better’, given the political realities of how rules and taxes are created, 99 percent of the time you create a counter effect that makes it worse, as a good idea is conflated with some targeted redistribution.

One point I didn't address was Fox's criticism of Basel II, which is quite interesting. He notes Basel is inconsistent, trying to be regulatory, and rely on market prices. But if you are trying to come up with capital adequacy, I don't see how you can do this without using all sorts of market data, because capital adequacy is a market issue. That is, regulators are concerned about market failure. Further, if you are estimating something like volatility, or value, and you ignore market prices, surely your estimates are arbitrary in a much less battle-tested way. In sum, if regulation is compromised to the extent it relies on market data, God help us all.


Anonymous said...

If we are going to socialize the downside risk for banks it would seem to me that markets will be ineffective in "self-regulating." If we are going to "trust the market" than we need to truly let that happen - in booms & busts.

Anonymous said...

If in the bad old days we had crises & now in the good new days we have crises, then regulation has not solved the problem, but nor did unregulated markets. Are you accepting the behavioralist argument that crises are inevitable given the dynamics of economic interaction and the EMH & Traditionalist rational market behavior is insupportable?

Anonymous said...

Have you seen this recent Eugene Fama interview on EMH? Good stuff: