Yesterday Senate Minority Leader Mitch McConnell (R-KY) appointed me to be a member of a new Financial Crisis Inquiry Commission...The purpose of the Commission is "to examine the causes, domestic and global, of the current financial and economic crisis in the United States."
I can remember my father telling me that a question such as, "What caused the first World War?" cannot be answered scientifically. We cannot run a controlled experiment to verify a hypothesis The financial crisis poses a similar challenge.
I could come up with a very long list of controlled experiments that would help sort out difficult issues. Off the top of my head....
1. An experiment where we change housing policy to get rid of the housing bubble. Does a bubble simply emerge somewhere else?
2. An experiment where monetary policy follows the Taylor Rule exactly. Does it make much difference?
3. An experiment where there are no bailouts. What happens to the financial sector, and what is the impact on the nonfinancial sector?
4. An experiment where government does not promote mortgage securitization. In particular, bank capital regulations are not written to allow banks to hold less capital for mortgage credit risk when the loans are bundled into securities and still held by the bank. How much of the fancy financial engineering that took place over the past decade was driven by regulatory capital arbitrage?
5. An experiment where exchange rates adjust to reduce capital inflows to the United States. Does that prevent a bubble from emerging?
6. An experiment where European banking is less concentrated. To what extent was the crisis exacerbated--and the bailouts motivated--by the fragility of banking systems in other countries?
7. An experiment in where Glass-Steagall restrictions are maintained, rather than gradually eroded starting in the 1970's. I don't think that this would have made much difference, but some people are obsessed with the issue.
8. An experiment in where we have a "systemic risk regulator." I don't think it would have made one ounce of difference, but the conventional wisdom in the regulatory community seems to be that if we just go back to where we were five years ago and add a systemic risk regulator, we'll be fine.