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The Department of Bad News

Dylan Ratigan has one of the better pieces celebrating Lehman Day (which marks the beginning of the bailout season in the Druid calendar). At this point, the country — and in particular, the chattering class — has done a much better job facing up to the failure of the financial system than the failure of the political system. The English Lit majors hawking CDOs deserve some portion of blame for the crisis, but so too do the politicians who decided that their job was to unleash Wall Street rather than fence it in, and the political appointees who convinced themselves that the good times were proof of their unique regulatory genius rather than the long party that always precedes an awful hangover.

The hardest question about our overhaul of the financial regulatory system is also the one that the plans still do not answer: How do you regulate the system if the Chairman of the Federal Reserve — and most everyone else — denies the existence of a problem? That, after all, is what led to the crisis of 2008. Greenspan might have commanded an impoverished regulatory apparatus compared to what Geithner means to create, but he could have done a whole lot more than he did. The problem was he didn't want to. Nor did most anyone else. That's what makes a bubble a bubble: People believe in it. And in the current set-up, Wall Street pays the political system to believe harder.

There's no cabinet-level agency dedicated to worst-case thinking (calling Secretary Roubini?), no Department of Buzz-Harshing whirring away somewhere on the periphery of the system. But that's what we need. Because the next economic crisis will look different. Overconfidence hasn't been banished from the financial system, much less the human psyche. Nor is there a regulatory measure capable of protecting against fads and convenient rationalizations. The result is we're giving regulators the power to stop bubbles, but not changing the necessary preconditions for bubbles. And granted, that's difficult to do. But at the least, we could create a louder alarm system, so it would be even harder for those caught in the excitement of the moment to say they never heard the warnings.

By Ezra Klein  |  September 14, 2009; 4:00 PM ET
Categories:  Financial Regulation , Solutions  
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Comments

I thnk the problem is actually worse than that. Had the Fed stepped in early and raised rates to choke off cheap credit, the political system would have rebelled and demanded that rates be dropped back down. There would have been a bipartisan outcry in Congress that the Fed was killing homeowners and entrepreneurs.

Posted by: tomtildrum | September 14, 2009 4:31 PM | Report abuse

Not to excuse the politicians and legislators completely, but another factor was competition with London for international finance business. Ten years ago New York was the undisputed international capital of finance. A year ago, the lead had moved to London. A large part of that was lax regulations outside the US. We were reducing regulation to keep some of the finance industry in New York.

One symptom is the word "eurodollar". Dollar denominated loans came to be traded outside the US because of regulations.

The consolation is that finance in London is suffering even more than New York.

The policy takeaway is that regulations have to be designed so that one cannot skirt them by moving overseas. Hopefully a well regulated transparent market will again attract business from abroad.

Posted by: congm | September 14, 2009 4:56 PM | Report abuse

We could start with regualting leveragew more, and then go on to tax incomes more. When the top marginal tax rates were much, much higher, it was cost-effective for corporations to retain earnings and plow them back into the corp. When marginal rates dropped below 50% and then to 35%, it was an irresistible temptation to transfer earnings to top management in the form of compensation. Short-term thinking dominated. See James K. Galbraith, "The Predator State."

Posted by: Mimikatz | September 14, 2009 5:21 PM | Report abuse

This is blasphemy, but I am thinking are we going to say the same thing about our current set of politicians a decade afterwards – what were these guys smoking when they passed a Trillion Dollar Health Care Reform bill? I am supporter of Obama care and I want it to be passed. Generally I do not like Robert Samuelson’s column in Post. But yesterday’s column put the exact finger on what is happening in this debate. His pointing about how fall back arrangements of ‘spending cuts’ when savings do not materialize (GSR cuts to Medicare) hardly come to fruitarian is scary. This means for all the Obama talk of ‘reducing costs when no savings’ may still turn out to be false. That will be a disaster. Are we similarly ignoring that disaster here?

Can we have a bill where irrevocable terms are there to reduce costs when savings do not come, the terms which Congress cannot alter, cannot postpone? In absence of that we may very well say how come so many Americans backed such an outrageous policy.

Posted by: umesh409 | September 14, 2009 7:36 PM | Report abuse

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