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Filling the Financial Regulatory Void « The Baseline Scenario
I would argue that the fundamental flaw in financial regulation is that it is based on the assumption that regulators are not self-interested individuals like the rest of us. We think about regulation only in terms of how to engineer the incentives of the regulated and ignore the fact that regulators themselves rarely have a stake in doing their job well, which in any other occupation would limit the motivation and types of individuals a position attracts.
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It is unlikely that consumers will ever hold much influence over the realities of the financial regulatory process because they are not organized in comparison to the financial industry, which concentrates significant resources in the creation of inefficient regulators. By and large, consumers are not well-informed about what they have at stake in the regulatory process and, even if they were, that would not be the sole determinant of how they define themselves politically.
Adding another layer of guards to guard the existing guards ultimately results in an infinite regress. I do not think it is cynical to suggest that, absent an actual paradigm shift with respect to accountability in the financial industry, we are just going to have more of the rent-seeking that has gone on to date and the economic calamities that ensue. For my part, I would propose opening up financial regulation to a small group of social entrepreneurs. Let people establish for-profit companies that can compete for government contracts to stress test the holdings of financial institutions independently and audit their records.
Ezra Klein - Will Health-Care Reform Save Medical Innovation? An Interview With Dr. Jerry Avorn.
Ah, Wall Street. Seeing the real you at last. » New Deal 2.0
Financial innovation was presented to us in a way that suggested that great things were happening for mankind. The presentations were usually vague. To understand them, we had only the power of our own imaginations, or perhaps, failing that, our awe in the face of this powerful expertise, confidently propelling us to a greater future....
Malarky. This is all code for defer to the wishes of those who make money from these techniques.
ITS-Davis: Automobiles on Steroids: Product Attribute Trade-Off s and Technological Progress in the Automobile Sector
This paper estimates the technological progress that has occurred since 1980 and the trade-offs that manufacturers and consumers face when choosing between fuel economy, weight and engine power characteristics. The results suggest that if weight, horsepower and torque were held at their 1980 levels, fuel economy for both passenger cars and light trucks could have increased by nearly 50 percent from 1980 to 2006; this is in stark contrast to the 15 percent by which fuel economy actually increased.
Stumbling and Mumbling: Regulation vs nationalization
4 arguments for strong regulation of banks. "But we regulate banks not because they'll make too much money, but for fear that, left to themselves, they'll lose too much."
The Elusive Green Economy - The Atlantic (July/August 2009)
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Exhilaration over clean energy has so thoroughly swept Silicon Valley that it has transformed the local culture. Conspicuous consumption has given way to conspicuous conservation. The favored status symbol is no longer the giant yacht or the sprawling mansion but the home designed to be so ruthlessly energy-efficient that it generates its own power
and
produces a surplus that can be selflessly fed back into the grid. One top venture capitalist who showed me his Portola Valley home had embarked on such a project and then, after choosing the reclaimed stone and composting toilets, had succumbed completely to environmentalist fervor and kept right on going, contracting with a local nursery to grow the flora necessary for a “native play meadow” and bringing in a team of wildlife biologists, equipped with motion-sensitive night-vision cameras, to lure back to their natural habitat the elusive riverine tortoise and dusky-footed wood rat that once roamed the property. A documentary film is in the works. -
The nut of the problem traces all the way back to Jimmy Carter’s choice of tax credits as the vehicle for subsidizing renewable energy. Direct grants would have been simpler. But Congress had recently changed the federal-budget process to keep closer track of how much money was being spent. It suddenly became easier to spend indirectly, by manipulating the tax code. Although no one realized it at the time, Carter’s decision to use tax credits lit the very long fuse on a bomb that detonated last fall and nearly took down the entire renewable-energy industry in America.
The trouble with tax credits is that in order to make use of them, you must owe taxes, and most start-ups struggling toward profitability do not. So while a company looking to build a wind or solar facility would qualify for valuable benefits, it had no means of realizing this “tax equity.” The work-around was to partner with someone who did, someone large enough to finance a $500 million facility and profitable enough to incur a large tax bill. Having witnessed two decades of busts and bankruptcies, traditional U.S. banks wanted no part of this. European banks, going by their more positive experience, were comfortable funding large renewable projects, but didn’t qualify for U.S. tax credits. The perversity of the government’s incentives demanded a big balance sheet, huge profits, and an indifference to risk.
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FT.com / Columnists / Martin Wolf - The cautious approach to fixing banks will not work
If institutions are too big and interconnected to fail, and no neat structural solution can be identified, alternatives must be found: much higher capital requirements and greater attention to liquidity are the obvious ones.
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“Never again” might be too much to ask. But “not for a generation” is essential. Governments cannot afford an early repeat, financially, politically, perhaps morally: the lives of so many cannot soon be sacrificed to the whims of a foolish few.
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If institutions are too big and interconnected to fail, and no neat structural solution can be identified, alternatives must be found: much higher capital requirements and greater attention to liquidity are the obvious ones. At present, big financial institutions operate with next to no capital: in the US, the median leverage ratio of commercial banks was 35 to 1 in 2007; in Europe, it was 45 to 1 (see chart). As I noted last week, this makes it rational for shareholders to “go for broke”, with the results we have seen. Allowing institutions to be operated in the interests of shareholders, who supply just 3 per cent of their loanable funds, is insane. Trying to align the interests of management with those of shareholders is then even crazier. With their current capital structure, big financial institutions are a licence to gamble taxpayers’ money.
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FT.com | Willem Buiter's Maverecon | Useless finance, harmful finance and useful finance
The endless churning of contingent claims, including derivatives, when the purchaser has no identifiable insurable interest, turns financial intermediation into a market-mediated betting shop. Then the betting slips become bearer securities and are themselves traded, either OTC or on organised exchanges, and the derivative transactions volumes expand to dwarf the transactions in the markets for the underlying financial claims (let alone the markets for the underlying real resources). At that point, the betting tip of the financial tail of the real economy dog does all the wagging. It does not create value but redistributes it in a way that consumes real resources and exposes the real economy to unnecessary risk. It’s time to tame the tiger.
Interfluidity :: A think-nugget from Arnold Kling inspires a very long riff...
Long essay on banking and capital intermediation.
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So how does the financial sector seem to offer risk-free assets against risky projects? I think "constructive ambiguity" is the right phrase. The government provides subsidies in the form of literally priceless deposit and liquidity backstops, but those are explicitly limited. Banks work to diligently to increase both the level of insurance and degree to which assets are perceived to be insured by becoming so large that social costs of a bank default on even notionally risky assets are thought to exceed the costs to government of paying out on insurance policies to which it never agreed. Even a very careful observer cannot tell a priori whether many assets offered are genuinely riskless or not, that is to what degree the risk-free status of bank assets is due to subsidy, and to what degree to subterfuge. But there is an ingenious tinkerbell aspect to the risk status of bank assets: If, with a bit of subterfuge, risky assets can be sold as riskless assets, then the social costs of default rise, since asset holders will not have privately managed the risk that the asset might fail. The increase in social costs created by a mischaracterization of a risky asset as riskless, however, alters the likelihood that an asset will be de facto insured. There is a game theoretic equilibrium, that works to the advantage of intermediaries and their customers on both sides of the funding stream, whereby banks offer assets in large quantities as though they are risk-free, and investors accept and treat those assets as risk-free, and by believing together in what is formally not true, they create costs to the sovereign so large if it is not true that the sovereign makes it true. This is an equilibrium, a predictable outcome, not an aberration. And it does happen all the time.
Open Left:: The Power Of Finance Is Killing America-It Needs To Be Stopped
Comparisons between political donation from finance and transportation.
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