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.