
Financial collapse shows failure of free markets? - peter123
http://blogs.law.harvard.edu/philg/2009/03/27/financial-collapse-shows-failure-of-free-markets/
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cwan
It's intensely frustrating that blame is being heaped solely on "wall street".
The resulting legislation is completely reactionary and will create all sorts
of unintended consequences not the least of which will result in restricting
funds to support the growth of firms that create real value. (Sarbanes-Oxley
anyone?) Perhaps even more irritating is the equivalency that critics place
between criticizing Wall Street and "free markets"/capitalism.

I don't think anyone would say that "wall street" did not play their role -
but it was a role played on a field designed by regulators - many of whom are
the same ones who now disclaim all responsibility. To quote Daniel Hannan, a
British MEP in a recent interview: "Don't make the same mistake that a lot of
people on the left make that financiers are for free trade. They're really
not. All financiers are monopolists. All financiers will grab a subsidy if
they can. Every big businessman left to himself is a corporatist and the
beauty of the capitalist system is it doesn't let them indulge that instinct
or at least it didn't until the last 6 months when we've suddenly turned the
clock back."

(As a side note, I used to be a financier)

~~~
crux_
As counterpoints, first consider that blame for the current situation and the
proper next steps are two separate issues. The myopic (to put it gently)
decisions made by "Wall street" most certainly are the single largest
contributing factor to the urgency and depth of this crisis.

Second, I think it's rather difficult to pin much blame on regulators. The two
levers used that have made this so particularly awful, CDOs and CDSs, were
almost entirely over-the-counter, unregulated affairs, and the extent of our
economy's exposure was and still is cloaked behind regulatory loopholes that
allow these firms to keep it at least partly off their books.

Funny, the language you use (financiers, corporatist, monopolists) makes me
think of Lenin's "Imperialism: The Highest Stage of Capitalism." Saw it in a
bookstore and flipped through, but I decided it would be too cynical for me to
buy it.

~~~
cwan
Fair enough to consider the situation and next steps as two separate issues.
But I really don't think that saying that Wall Street is the largest
contributor is fair. It is quite easy to pin the blame on regulators who
encouraged high levels of debt and large levels of regulation that financiers
sought to work around and game. They were given the incentives to pursue
destructive policies (ironically those with the lowest levels of regulation -
hedge funds, private equity, etc aren't causing the level of systemic risk
that was initially feared).

CDS and CDO products were not to blame (they may well have have been
contributors) - but if you look at the aftermath, their role was overblown
(net everything out and the amounts are relatively small). Maybe that's the
issue here in that there isn't a lot of understanding as to what the causes
have been - and there clearly were several. Rich Kilgaard calls the problem as
being one of "capital on strike". Credit markets have been freezing up because
no one really knows who to trust and whether stated numbers are real and what
the values of assets are. The levels of leverage is either a primary or
secondary problem depending on who you ask.

The chairman of FedEx has been talking about the problem and relationship
between high taxes and leverage for a long time. High taxes and double
taxation of dividends means that the tax code favors companies taking on
greater amounts of debt over what would be more stable but already expensive
equity (ie you can expense interest but you can't expense dividend payments).

And then finally - something that we can definitely squarely lay the blame at
the feet of regulators is the promotion of home ownership to those who
couldn't afford it. Look at the levels and amounts of subprime lending post
revisions to the CRA in 1999. Heck, if memory serves, the first subprime MBS
was about a week after its passing. Bush working with a Democratic Congress
was also to blame in encouraging Fannie Mae and Freddie Mac to continue buying
up basically any mortgage that was written. What Wall Street did - which
really complicated the mess was create investment vehicles that weren't
transparent relative to the underlying assets making them difficult to
understand and subsequently break apart.

Then you have such things as mark to market which really sped up the decline
of financial institutions in the US. As a principle, it's laudable - the basic
idea being that your assets should be valued as close to what the market
thinks as close to real time as possible. The problem when it comes to
regulatory capital calculations is that when you have a large market
essentially stop trading, or collapse in value (even if the loans will be held
to term), is that you rapidly have "undercapitalized" institutions in the
worst of markets - made particularly worse by the levels of leverage they have
(the situation in Europe here is far far worse - and the irony is that they
are far more regulated).

Then there's the fed which kept interest rates too low for far too long which
allowed for an asset bubble which in turn fueled demand for debt. And now
Geithner is attempting a massive power grab in the middle of all of this. He
wants to have the power to force unregulated institutions into insolvency -
this despite the fact they're not like banking institutions where they are
obligated to guarantee deposits up to a given amount per FDIC. So now the end
result is that venture capital funds and private equity firms may need to
report to the SEC resulting in higher costs and regulations - costs I would
add that mean aren't going back into investing in productive parts of society
for problems that may or may not even exist!

It's a big mess but everywhere you look, regulators and government agencies
had their grubby little hands everywhere.

~~~
crux_
Further counterpoints... (warning; I'm a touch sleepy).

First, there is the primary issue, severely undermining almost everything you
write, of "encouraging" vs "doing". (I'm making an assumption here:) It's
really quite ironic to see a libertarian claiming that one who encourages a
decision bears greater responsibility than the individual who actually made
the decision him/her/itself.

In other words: if I take you at face value, the regulators encouraged bad
behavior, individuals and institutions behaved badly, and it is the former who
bears the majority of the blame. Pardon me if I don't buy it. Sure, the
regulators screwed up, but to a tar-and-feathering degree rather than a
torches-and-pitchforks level.

Further complicating the "regulators are more to blame" approach, even if we
overlook the basic contradiction at its core, are the issues of regulatory
capture: Wall Street and the regulators in question are pretty much the exact
same people at this point, and their motives pretty much identical (due to
many reasons; e.g. the revolving door). (I digress, but I believe this is a
big part of the reason the current response has sucked so badly: too much Wall
Street, not too much regulators!)

Finally, although I'm sleepy, I believe I detect huge amounts of spin in your
response here. A couple of examples: CDS contracts entered into by AIG were
rather larger than the entire value of the company, for example, not what I
would call a "relatively small" amount. And Geitner doesn't want to "force
unregulated institutions into insolvency" ... the institutions in question are
already insolvent! What he wants is, presumably, is to force them into
something along the lines of a slowed-down, taxpayer supported restructuring
(aka: bankruptcy). This may or may not be a good thing but to cast it as
"forcing an organization into insolvency" is duplicitous.

~~~
anamax
> Further complicating the "regulators are more to blame" approach, even if we
> overlook the basic contradiction at its core, are the issues of regulatory
> capture:

Regulatory capture is a consequence of regulation, so its effects are problems
with regulation.

> CDS contracts entered into by AIG were rather larger than the entire value
> of the company, for example, not what I would call a "relatively small"
> amount

And they were hedged by contracts that were of comparable size. That's how
insurance companies work.

And all of this was approved by regulators. In AIG's case, by both bank and
insurance company regulators in the US and (at least) bank regulators from
other countries. (I don't know if other countries also regulated AIG as an
insurance company, but I suspect that they did.)

Note that the foreign banks that bought AIG policies did so with the express
permission of their regulators. We know that because banks get no benefit from
unregulated assets.

~~~
crux_
> Regulatory capture is a consequence of regulation, so its effects are
> problems with regulation.

My point was that if we are looking for people to blame, whether we chose to
point the finger at Wall St or at "regulators," it turns out it will be the
exact same group.

> And they were hedged by contracts that were of comparable size.

Not at AIG they weren't, which is why so much of our taxpayer money is flowing
through them to the counter-parties of their CDS contracts -- e.g., Goldman
Sachs.

> Note that the foreign banks that bought AIG policies did so with the express
> permission of their regulators.

So when a regulator gives you permission undertake an activity, by doing so
they also lift all responsibility from you when you choose to go ahead with
it? Regulators have made it possible for me to drink, does that mean it is
their fault when I contract alcohol poisoning?

~~~
anamax
> My point was that if we are looking for people to blame, whether we chose to
> point the finger at Wall St or at "regulators," it turns out it will be the
> exact same group.

Actually, it's not. Unregulated Wall St has fared far better.

>> And they were hedged by contracts that were of comparable size.

> Not at AIG they weren't

Yes, they were - that's how regulated insurance works.

> which is why so much of our taxpayer money is flowing through them to the
> counter-parties of their CDS contracts -- e.g., Goldman Sachs.

The money is flowing because the assets backing up the liabilities weren't
actually worth enough and the risk was underestimated.

> Regulators have made it possible for me to drink, does that mean it is their
> fault when I contract alcohol poisoning?

It means that you can't say that regulation solves alcohol poisoning.

~~~
crux_
> Actually, it's not. Unregulated Wall St has fared far better.

Like Bear Sterns, Lehman Brothers, Goldman Sachs?

> It means that you can't say that regulation solves alcohol poisoning.

I never claimed this. What it _does_ mean is that you cannot say that
regulation causes alcohol poisoning.

~~~
anamax
> What it does mean is that you cannot say that regulation causes alcohol
> poisoning.

Since, in your case, the regulator was providing the alcohol, it's fair to say
that the regulator deserves some blame.

We're somewhere between "regulators were completely useless" and "regulators
actively caused problems". It's hard to see how that leads us to "we need more
regulators".

And yes, the regulators and the banks were the same folk. That's another
argument against expecting them to help.

~~~
crux_
"we need more regulators"

When did I make this argument? No, it is a convenient strawman for you, and a
way of changing the topic away from "Who is to blame for the stupid, stupid,
stupid decisions on Wall Street and their rather disastrous consequences?"

I'm willing to apportion _some_ blame to the regulators, but it's quite
amusing to see the hypocrisy of some libertarians when they rush to shield the
banking and finance industries from the scorn they so richly deserve; blaming
anyone and everyone (usually regulators and/or the government, conveniently in
line with their ideology) except for the individuals responsible for the
decision!

To paraphrase a common libertarian lament, whatever happened to individual
responsibility?

~~~
anamax
> When did I make this argument?

All of these discussions are in a context of "what do we do?" with "more
regulation" being one of the options.

~~~
crux_
No, these (specific) discussions are not in a context of "what do we do?" I
think it encourages clearer thinking to tackle one thing at a time. Allow me
to quote myself in the first sentence of my first post in this thread:

> As counterpoints, first consider that blame for the current situation and
> the proper next steps are two separate issues.

~~~
anamax
>As counterpoints, first consider that blame for the current situation and the
proper next steps are two separate issues.

Knowing how you got to where you are is relevant to knowing what to do. If you
prefer, insanity is doing the same thing and expecting a different result.

I'm not interested in punishing anyone, so "blame" has the wrong connotations.
It's actually credit assignment. Do more of what works, do less of what
doesn't.

------
fallentimes
There never were free markets.

~~~
gnaritas
Nor will there ever be, free markets are a fantasy. The only real free market
is the black market.

~~~
cwan
Free markets require rule of law and property rights to thrive. That's the
problem with black markets. You can't monetize some of the less tangible
assets required to operate in formal markets. This is something that Hernando
De Soto has written a considerable amount about.

For an example - developing markets because of the lack of property rights, a
lot of people don't have the ability to borrow against their homes - or even
properly sell them. And what prices they do get, are at a discount because
they have illegal additions, or what have you. Same thing for businesses that
can take years to start and formalize (that's just for the paperwork!).

Check out the World Bank's doingbusiness.org - and the places that are most
difficult to do business consistently have the largest thriving black markets.
Those markets definitely are not free. Black markets are definitely not the
answer.

~~~
gnaritas
You make good points, but you misunderstand, I wasn't claiming they were the
answer.

------
nazgulnarsil
financial collapse shows that the incentive structures in the financial
industry were completely insane. Only in a world where dubious loans could be
sold off en masse to government lenders does the so called "predatory lending"
occur.

what incentive is there to do honest business when you're going to collect
your commission and then wash your hands of the loan?

------
trapper
If only shuffling money couldn't make a profit.

