Friday, March 27, 2009

Listen Up Secretary Geithner

A Utopian re-regulated financial sector, as envisaged by some pundits, would seek to avoid financial institutions’ taking excessive risks that could create systemic fragility, and give supervisors enough power to forestall any bubbles they saw developing. This regime would continue to facilitate the smooth and safe channeling of savings into socially productive investments, guaranteeing the future prosperity of a newer, low-risk world.

Before Americans — or Canadians — put too much stock in this imaginary future, however, they should ask if a regulator could recognize excessive risk and fragility as it began to emerge, could spot the point at which a boom that delivered socially productive innovation became a destructive bubble and subsequently design measures to halt the transformation without also discarding productivity gains. And they should ask how this wisdom would be translated into regulations that could be understood, followed and enforced by ordinary human beings in an environment where disagreements about how to interpret them will inevitably arise, and where decision makers’ own interests are affected by regulations’ interpretation.

The crucial point, which must not be missed in a populist rush to re-regulation, is that today’s financial systems in the U.S. and elsewhere are not the product of an unregulated market, but of a long history of interactions between regulatory interventions and private innovations in response to them.

The above is from the extremely wise Canadian monetary theorist, a student of the late Milton Friedman I believed and a retired professor at U of Ontario, David Laidler.

There are other bits in the piece where Secretary Geithner should pay attention, like this one:

First, as the U.S. financial system reconfigures, its evolution may be no more satisfactory under a newly minted set of rules designed to prevent past accidents than it would be if the process were driven by piecemeal, profit-seeking trial and error on the part of the private sector.

Regulators and the politicians who oversee them must remember that the profit motive is ever present, and that those who found ways to make money under past regulatory models will seek to do so under the next regime, too. The trick will be to design incentives so individuals’ behaviour stabilizes the system, rather than undermines it.

Read the whole thing here. And a list of David Laidler's works could be found here.

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