I have just watched the latest episode of Frontline--the warning. It documents how Brooksley Born, the former chairperson of CFTC, tried in vain to regulate the derivative market that is at the core of our current crisis. Here are some of my thoughts.
1, Great Asymmetry. Even amid the global economic turmoil, I am not ashamed to admit that my belief in free market is as strong (or even fervent) as ever. However, it is well-known that the prerequisites for the function of the market are rewards for success and punishment for failure. According, rewards for failure should undoubtedly be seen as a distortion. The problem in the current system is inadequate punishment. Considering the unaffordable collateral damage, governments all over the world spare no effort in bailing out the banks. The action on the part of the government is consistent with their political responsibilities, because otherwise, lives of people on the main street will be at their perils. Ok, let me speak in plain English. It is ok for the banks to be reckless and ruthless as long as they are left to clean up their own mess. By contrast, it is unjust and outrageous if taxpayers do not get to partake in the feast but have to pay for the bill when thing go wrong. This is probably why Anna Schwartz was so adamantly oppose to the rescue plan. In her words, “Everything works much better when wrong decisions are punished and good decisions make you rich.”
It seems that the asymmetry in the system of rewards could be deemed as capitalism in prosperity and socialism in recession.
2, How much regulation is adequate? The Frontline documentary reasons that if a firm or a transaction imposes a systematic risk on the market, it should be subject to proper regulation. Appalled by the fraudulence in the unregulated market, I tentatively agree that OTC derivatives are ought to be supervised. Other proposals such as the expansion of US regulatory agency also appear to have their merits.
Nevertheless, I can’t help but wonder when the regulation will be sufficient? During an interview, William Donaldson, the former head of SEC, when explaining why they did not catch Madoff, complained that the tips were so numerous that there was no way that all the noteworthy messages could be duly noted. If that is the case, even doubling the staff of SEC would not solve the problem.
In fact, the overemphasis on regulation could be the start of the slippery slope towards soviet economy, where everything is closely monitored by the government.
3, Friedman’s Utopia? According to Milton Friedman, before the foundation of FED, banks used to form an association which could come to the rescue of member bank in trouble. To many people, including me, nothing is more desirable than the voluntary cooperation. Please note the differences between this organization and the FED. The Chairman of the FED is appointed by the President and answerable to the congress. Meanwhile, the association is accountable to no one but the banks. Although it is entirely possible that in this way, banks can be better regulated, my scanty (historical) knowledge makes me incompetent to judge whether it is still a viable option for the current society.
Note 1: It is unfair to claim that the public are entirely innocent in the crisis. Since the lifestyle of the typical Americans (i.e. excessive consumption and inadequate saving) is the “micro-foundation” of the global imbalance, men are all “sinners” in this sense.
Note 2: The remedy advocated by Alan Greenspan is higher capital requirement and thus lower leverage. It is surely a policy in the right direction.
jg-xs1
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