Arnold Kling  

The Regulators' Cognitive Failure

Repugnantly Corrupt Bargains... Unchecked and Unbalanced

The Washington Post reports,

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.

I would add that the suits at the banks did not really understand the risks they were taking, either. This is a key point of the first chapter of Unchecked and Unbalanced. Where there was power, there was not knowledge. The concentration of power in an age of dispersed knowledge is what the book is trying to highlight and to combat.

Read the whole story. My favorite anecdote concerns a colloquy between Ben Bernanke and Richard Dekaser, a bank economist who worried about house prices in California in 2005.

"They have been saying that about California since I bought my first house in 1979," Bernanke replied.

Comments and Sharing

COMMENTS (6 to date)
Patrick C writes:

Bernanke continues to impress. Or not.

SydB writes:

"did not really understand the risks"

Or they simply didn't care to understand the risks.

"My favorite anecdote concerns a colloquy between Ben Bernanke and Richard Dekaser"

I think it incumbent on you to point out to your readers that you were also arguing fairly strongly that housing prices were a-ok and, at or near the hight of the bubble, you suggested it might still be a good time to purchase a house or rental property.

"Where there was power, there was not knowledge. The concentration of power in an age of dispersed knowledge is what the book is trying to highlight and to combat."

I think accountability is key. And checks on power.

fundamentalist writes:

Banks purchased securities with AAA and AA ratings. And they follwed the Basel accords to the letter. Those accords were intended to reduce risk. Where did the ratings agencies get the idea that these securities were safe, and where did the drafters of the Basel accords get the idea that their regs would reduce risk? From mainstream macro.

simone writes:


What is accountability? Let's stop creating labels to disguise ignorance and blame shifting. Accountability is what Obama and the Congress are taking on with Economy, Health Care, Global Warming, etc. Please!

Dewey Munson writes:

“Our colleague Rob Arnott, who always does terrific research, wrote in his recent report that "at all levels, federal, state, local and GSEs, the total public debt is now at 141% of GDP. That puts the United States in some elite company--only Japan, Lebanon and Zimbabwe are higher. That's only the start. Add household debt (highest in the world at 99% of GDP) and corporate debt (highest in the world at 317% of GDP, not even counting off-balance-sheet swaps and derivatives) and our total debt is 557% of GDP. Less than three years ago our total indebtedness crossed 500% of GDP for the first time."

Add the unfunded portion of entitlement programs and we're at 840% of GDP.

The world has not seen such debt levels in modern history. This debt is not serviceable. Imagine that total debt is 557% of GDP, without considering entitlements. The interest on the debt will consume all the tax revenues of the country in the not-too-distant future. Then there will be no way out but to create more debt in order to finance the old debt.

It assures a period of economic devastation. In a last, desperate attempt, politicians at the federal and local levels will raise taxes to astronomical heights to raise revenues. And that only assures destruction of the economy. Forget the fable of economic recovery. Unless there is a change in Washington by next year's election, there will be no way to turn back.

Japan's recession is now 19 years old. It has the highest debt-to-GDP level (227%) of any industrialized country. The Fitch rating agency is talking about a potential downgrade of Japan's debt. Japan's stock market is still down 75% from the high in 1990. We predict it will make new bear market lows next year. That will make it a 20-year-long bull market on the way to 25 years. The bulls in the U.S. should consider that possibility in the formerly great United States of America.

I do not believe the bullish theory that the U.S. situation is different than Japan's. Ours is so much worse.

Is it any wonder that our biggest creditors, China, Russia and the Middle East, are diversifying out of the dollar and into gold?”

Mike Rulle writes:

I hesitate to go "EMH" on this topic. But if one did a "meta-analysis" on concurrent commentary and analysis during this decade, would there have been more "warnings" about economic disaster or about the same as usually exists? My guess is "about the same".

I obviously don't know the answer and my comment is not original. But my belief is we do not make accurate predictions of this nature. We also trick ourselves with after the fact data and logic "fitting".

Ideally, this is not true. But I find our desire for explanations to be psychological in nature. It is as difficult to make predictions about economic recessions/depressions before the fact as it is for a central planner to outperform the spontaneous order.

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