Arnold Kling  

Short Papers on the Financial Crisis

Are Grotesque Hypotheticals Ch... Who Loses From Efficiency?...

From the Cato Journal. Some excerpts below.

[update: Also, read an interview with Richard Posner on his new book. Thanks to Tyler Cowen for the pointer.

Posner writes,

The riskiness of banking can be reduced by regulation. But as a result of a deregulation movement that began in the 1970's, the industry was largely deregulated by 2000.

Which regulations does he want to bring back? Restrictions on interstate banking? Deposit interest ceilings? The inability to pay interest on checking accounts? ]

Allan Meltzer:

First, we should close down as promptly as possible Fannie Mae and Freddie Mac. There never was a reason for those two institutions, other than to avoid the congressional budget process. The benefit that people got from Fannie and Freddie came from the subsidy to the mortgage interest rate. Congress could have passed that subsidy over and over again. They avoided passing it by taking the program off budget.

Read the whole thing.
Donald Kohn:

I still have serious questions about whether trying to use monetary policy to check speculative activity on a regular, systematic basis would yield benefits that outweigh its costs.

He is still stuck in the monetarist paradigm in which money is this super-powerful tool for controlling the economy, and you don't want to use this super-powerful tool to deal with little things like speculative bubbles. I think that in ten or twenty years, the paradigm will be that we need to focus on financial institutions and regulation, and we don't want to use the tools of regulation to deal with little things like the money supply.

Interesting paper by Otmar Issing on the same topic.

Bert Ely offers a view of regulation dynamics that is consistent with my "chess game" notion. For example, he writes,

The Internal Revenue Code, specifically the laws governing the taxation of personal and corporate income, are perhaps the single most important underlying cause of the financial crisis. Taken together, the tax laws promote overspending and undersaving by individuals and excessive leverage by both individuals and corporations.

One interesting point that Ely makes is that credit rating agencies enjoy first-amendment protection from lawsuits. That is, they cannot be sued for merely expressing an opinion. However, other professionals who express opinions can be sued--accountants, for example.

Ely thinks that Glass-Steagall should have been repealed sooner.

[investment banks] might not have become as focused as they did on buying, securitizing, and trading subprime, Alt-A, and option-ARM mortgages. While the large commercial banking companies also engaged in mortgage securitization and originating nonprime mortgages, they did not get as deeply involved in those activities as did the investment banks. Arguably, then, had the separate, distinct investment-banking industry been melded into mainstream commercial banking years ago, today's mortgage and financial crisis would not be as severe as it is, or may not have occurred at all.

William Poole emphasizes private sector mistakes.

The way forward is to enact tax law changes that will improve the long-run stability of the economy by reducing the incentive for leverage, and by encouraging a substitution of business investment for consumption.

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COMMENTS (3 to date)
David Beckworth writes:


I attended the CATO monetary policy conference when these papers were presented and thoroughly enjoyed it. No one can say there is no diversity of views at CATO, at least at this conference, as there were some presenters calling for a return to a commodity standard, others simply calling for a better run Fed, and others blaming the problem entirely on the private sector.

By chance I ended up walking out of the auditorium the same time as Donald Kohn and had a brief, but interesting conversation with him on the deflation scare of 2003 that I reported here.

robert W. writes:

I recently watched part of a history channel program titled "crash, the next great depression." In this "hackish" hit piece on capitalism, they blamed the great depression and the current financial crisis on republicans and deregulation. Their ideas were so one sided as to make even michael moore blush!

Some of that regulation could be described as Financial Repression {a concept that seems to confuse too many} and thus I must have a shout out to Ronald McKinnon.

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