This morning Paul Krugman thrashes around like a bass on a hook in a futile attempt at shoring up financial regulation in the form it has taken in the Congress:
…in any case, how good is the legislation on the table, the bill put together by Senator Chris Dodd of Connecticut?
Not good enough. It’s a good-faith effort to do what needs to be done, but it would create a system highly dependent on the wisdom and good intentions of government officials. And as the history of the last decade demonstrates, trusting in the quality of officials can be dangerous to the economy’s health.
His solution? A set of “rigid rules” that rely on the quality of other officials to enforce:
So what the legislation needs are explicit rules, rules that would force action even by regulators who don’t especially want to do their jobs. There should, for example, be a preset maximum level of allowable leverage — the financial reform that has already passed the House sets this at 15 to 1, and the Senate should follow suit. There should be hard rules determining when regulators have to seize a troubled financial firm. There should be no-exception rules requiring that complex financial derivatives be traded transparently. And so on.
That’s just temporizing. He’s stuck with same problem that’s at the root of any attempt at managing something as complex as the financial system from the top: who guards the guards? Even with perfect knowledge, itself an impossibility, the regulators will fail because they are human, subject to whims, prejudices, sloth, agendas of their own, and ideologies.
The rules that Dr. Krugman longs for are inherently backward-looking. They are always strategies for fighting the last war and, consequently, will be inadequate to deal with the next crisis which, we should remember, will be fomented by intelligent actors, intent on furthering their own best interests.
Robust regulatory schemes align incentives with preferred courses of action. Rather than trying to hold back the tides with a dike, you channel their force to divert it into the direction in which you wish it to flow.
This may show my ignorance on the topic of regulation, but it seems to me that simplicity matters. Regulation, ideally, should be more like rules for sports and focus on the big picture instead of attempting to micromanage outcomes, which is what they currently appear to try to do.
I think there’s a relationship between this post and the post I wrote on legal interpretation over the weekend. In all honesty I think we’re in need of a reboot. The hundreds of thousands of pages of laws and regulations, coupled with the millions of pages of legal opinions accreted over the years are impossible for anybody to understand.
Our last reboot was 300 years ago. We had what might have be thought of as a warm boot about 80 years ago (which followed hard on the heels of another warm boot about 30 years previously). The warm boot is now thoroughly sclerotic.
You assume that we are always able to align incentives. I am not sure we can align the incentives of a CEO, his company and the economic needs/goals of a nation.
Steve
I have to laugh….because this is something very similar to what Prescot and Kydland argued for with regards to time inconsistency and rules rather than discretion.
I don’t think you’d have to work too hard to guard the guards since with hard rules you’d have a fairly east metric if they did their jobs or not.
The problem is that you have to get another set of guards, called politicians, to neuter themselves by taking themselves considerably out of the equation. No more discretionary policy. No more fine tuning. It either follows the rule or it doesn’t.
For example Milton Friedman argued for a monetary rule, that the money supply expands at x% year in and year out. Thus inflation would be stabilized and contained. Of course, this makes it hard for the Fed to use monetary policy to influence the economy.
steve, steve, steve, you aren’t supposed to. The CEO’s responsibility is to share holders, not the country. That is why letting CEO’s have a say in national policy is dubiuos at best. Further, the implicit assumption that the economy is something that can be fine tuned is just a fantasy. Overall the economy tends to grow, and providing a healthy environment is at most what our government should do. Now we have a form of corporatism (which is why I laugh at morons like Michael Moore). We have big government so intertwined with big business the two are almost indistinguishable now.
A reboot is out of the question by the way. Over the past 80 years we’ve given so much power to the government that it just isn’t going to happen. They’ve got the power, the guns, and the legal system on their side. As much as we may need we aren’t going to get it.
Change you can believe in, right?