The Inevitable Crisis
David Brooks says that folks who think better regulation could have prevented this crisis or that better regulation will prevent the next crisis are fooling themselves — big government’s just not up to the task:
To sum it all up, this supposed new era of federal activism is going to confront some old problems: the lack of information available to government planners, the inability to keep up with or control complex economic systems, the fact that political considerations invariably distort the best laid plans.
This doesn’t mean there’s nothing to be done. Martin Wolf suggests countercyclical capital requirements. Everybody seems to be for some updated version of the Resolution Trust Corporation, though disposing of complex debt securities has got to be more difficult than disposing of commercial real estate.
I’m not sure this is right (not sure political pundits should be making confident assertions about financial regulations) but I do think it’s plausible. But if it’s right — or, rather, if we decide to make policy based on the assumption that it’s right — then it has some much broader implications. By targeting his ire at unnamed regulation enthusiasts, Brooks manages to somewhat obscure the fact that his conclusion — that we should passively accept the inevitability of crises and the need for post hoc taxpayer bailouts — is totally unacceptable. His logic, however, is a good deal better. But where this leads is to the point that while we may not have any idea how to organize a regulatory scheme to keep well-credentialed con artists from making hundreds of millions of dollars by screwing things up so badly that taxpayers need to spend tens of billions cleaning up the mess, we most certainly do know how to put higher taxes on extremely high-income people and spend the money on social services for the broad mass of people.
After all, right now the floor for the top income tax bracket is actually pretty low. We could add many new brackets so that a guy earning $300,000 a year isn’t paying at basically the same rate as someone earning $30 million. The rates near the top could get really punitive and confiscatory. Maybe if that was the case the best and the brightest wouldn’t have strong incentives to go into investment banking, but . . . so what?
48 Responses to “The Inevitable Crisis”
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September 19th, 2008 at 11:30 am
1) Of course, David Brooks argument also explains why we shouldn’t have laws and a justice system. The government just can’t get the information it needs and operate competently.
2) Brooks’ argument actually makes sense. If not for the heavy hand of legal penalties, there are about 30 lying cocksuckers in Washington DC and New York that I would have exterminated by now. One of whom is David Brooks.
3) And the country would be much better off.
4) So Dave’s right — the government doesn’t work and instead hampers efficient operations by the free market via overregulation and perverse disincentives.
September 19th, 2008 at 11:31 am
I think progressives could make some hay by proposing what you suggest: adding additional tax brackets at the top rather than just increasing the current top marginal rate. Raising marginal tax rates on people making $350,000 could induce some serious negative consequences economically–especially considering that the $350,000 could be one person making $250,000 and a spouse making $100,000. Raise the marginal rates on them and it starts getting much less worth it for the lower-earning spouse to work at all.
But, chances are, if you’re making, say, $5+ million, your labor supply decision is not very elastic–if it were, then you probably would have retired already.
September 19th, 2008 at 11:32 am
on a roll today, matt.
September 19th, 2008 at 11:33 am
New brackets would probably be a good idea, and capture the difference between the guy making six figures and the guy making eight in a way that is being lost right now. (Though the latter might well just move off-shore.)
But I think Brooks is wrong. Those old Austrian canards about imperfect information seem a little weak these days, and run up against the problem that imperfect information presents to private entities, too. Nobody with any sense is going to still believe that the price of a good conveys a damned thing after this crisis, so where is this “wisdom of the market” supposed to come from?
And Brooks is simply wrong about “highly regulated investment banks”, so much so it raises questions about his credibility and honesty. The real exacerbating factors here were non-regulated markets like the one in credit default swaps, and the current situation came about because people like Gramm removed the regulation on investment banks. And to blame Fannie and Freddie as “miscreants” is just farcical; Fannie and Freddie were not blameless in this, but they mostly ended up holding the bag for the investment banks’ failures.
And his comments about the Fed as an organization that “manages inflation, unemployment, bubbles and maybe hurricanes?” Yeah, that just shows that he’s almost completely ignorant about what the role of a central bank is supposed to be. A central bank that doesn’t care about unemployment or bubbles is…well…it’s Greenspan’s. We all know how that ended.
No, Matt, it seems to me like Bobo is just holding the line for his market fundamentalist buddies, spinning furiously while they try to salvage what’s left of their failed ideology. It’d almost be funny, if real people weren’t suffering.
September 19th, 2008 at 11:34 am
Brooks is a hack – his argument doesn’t hold water.
From the article:
Moreover, there is a lot of lamentation about Clinton era reforms that loosened restrictions on banks. But it’s hard, as Megan McArdle of The Atlantic notes, to see what these reforms had to do with rising house prices, the flood of foreign investment that fed the credit bubble and the global creation of complex new financial instruments for pricing and distributing risk.
I love the way he just put that on the Clintons without noting that the bill in question was Gramm’s bill.
But regardless – the reality is that if the SEC had not stripped down their requirement of investment banks to maintain a decent leverage (12-1 vs. 60-1), then many of these problems would not have occurred.
If the Fed had put in place mortgage regulation that required even basic documentation of income for a loan, then we would not have had the mortgage issues in the first place.
Brooks is making it sound like we have to just throw up our hands because the problem is unknowable – which is just complete crap. The Fed knew housing would be a problem well before it happened – they just followed their ideology (deregulation is always good) rather than noticing what was actually happening.
I expect we’ll see the Republicans make this argument over and over – that it’s actually the Clintons fault (they played a part but this really got going starting after 2001), that it’s a result of giving the poor mortgages (the marketing to these groups by the mortgage companies shows this isn’t the case), and that, if all else fails, hell, it’s IMPOSSIBLE to know about these things in advance and therefore we couldn’t possibly have done anything. And therefore we shouldn’t do anything in the future. What a load of crap. Reminds me of the 9/11 Commission saying the same shit.
September 19th, 2008 at 11:39 am
david brooks really, really doesn’t know what he’s talking about here.
and that may have been the greatest don williams post ever!
September 19th, 2008 at 11:41 am
Oh, and you’ve forgotten a rule of thumb, Matt: nobody who quotes Megan McArdle is to be taken seriously. I know she’s your former co-worker and all, but she’s been ludicrously wrong-headed about economics since she was “Jane Galt”. Nothing’s changed except the masthead.
September 19th, 2008 at 11:44 am
This is just typical perfect as the enemy of the good stuff. Of course perfect regulation is impossible to achieve. But that in no way implies you can’t have better and worse regulatory schemes.
September 19th, 2008 at 11:50 am
If pace Brooks’s argument, crises are inevitable and regulation won’t prevent them, why are we bailing out financial institutions now at such great expense? Since the public pays either way, why bail out the investors?
September 19th, 2008 at 11:51 am
If the Fed had put in place mortgage regulation that required even basic documentation of income for a loan, then we would not have had the mortgage issues in the first place.
This is my big unanswered question about all this: how does the money lost from home buyers defaulting on their mortgages compare to the money lost from massively leveraged investments based on those mortgages?
Because my gut feeling is that the second is vastly larger than the first, which would suggest that the real problem is with the leveraging, and not so much with the mortgages themselves. Please advise.
September 19th, 2008 at 11:54 am
james, you are correct: the problem was the leverage.
even now, there aren’t close to enough defaults as such….
September 19th, 2008 at 11:54 am
Maybe if that was the case the best and the brightest wouldn’t have strong incentives to go into investment banking, but . . . so what?
Maybe I need another cup of coffee, but was this intended to seriously imply that our “best” (clearly not our brightest) got us into this mess?
September 19th, 2008 at 11:55 am
Everybody says we’re about to enter a new political era, rich in global financial regulation. The herd might just be wrong once again.
As with Iraq, Brooks proves he doesn’t know the difference between listening to the people who were RIGHT and listening to the people who were WRONG.
The people who were right about the impending crisis were the people who warned we needed more regulation. The people who were wrong about the crisis were the ones who said we didn’t need more regulation.
Brooks is trying to obscure this by pretending that the same people who said “we don’t need regulation” are now the ones saying “here are the regulations we need.” With the exception of John McCain who is holding BOTH positions simultaneously–Brooks is wrong.
September 19th, 2008 at 11:59 am
Oh for f**k’s sake will we ever, ever get over this “big government” nattering in this country? There are plenty of other developed nations with complex financial markets and one hell of a lot more oversight than we have, and they function perfectly well. It really, really isn’t terribly difficult to develop effective regulation when the majority of your citizens demand it. It’s only difficult when you’ve got a blowhard, ignorant, ideologically rigid minority insisting that the only sensible way to drive a car is with somebody’s foot on the pedal and nobody steering. And it doesn’t help to have that minority backed by an equally rigid class of second-rate academic economists trumpeting results from arcane models that supposedly provide an intellectual buttress to the nonsense.
September 19th, 2008 at 12:12 pm
In reality, Matt, the guy making $30 million a year is probably paying a lower overall tax rate than the guy making $300k a year. That’s because most of his income typically would come from capital gains, which are given preferential tax treatment by the federal tax code.
I say, get the government out of the business of favoring one type of income over another. Treat capital gains as ordinary wage income and you’ll at least equalize the tax rates paid by your two example lucky duckies.
September 19th, 2008 at 12:16 pm
DCBob – I agree with you. It’s one thing for an advanced, rich, western democracy that believes in heavy government involvement in the economy (let’s call it socialism, for simplicity’s sake) to practice it effectively. It’s less certain that a big, rich country that hates socialism would be able to practice it well.
About 10 days ago we entered into a new era of Republican socialism, and I’m not sure the Republicans possess the earnestness and technocratic merit required to pull it off effectively. Put simply, Danes, believing in socialism, are more likely to be successful in it. The US, detesting socialism but nevertheless now practicing it, is likely to fail. What that failure will look like is unknown but will probably be pretty bad in any case.
September 19th, 2008 at 12:25 pm
Jerry, in recent years, upwards of 20% of Ivy League grads go to Wall Street to work at investment banks, and a similar percentage go to work at consulting firms. That’s the reference Matt is making.
http://www.nytimes.com/2008/09/18/opinion/18cohen.html?_r=1&oref=slogin
September 19th, 2008 at 12:27 pm
Matt, Matt, Matt.
The first rule of reading David Brooks is
Don’t talk about reading David BrooksDavid Brooks is full of shit, or, as we call it around here, conservative talking points.September 19th, 2008 at 12:29 pm
Setting aside the question of whether the financial services industry is a net social good, the main reason people go through the huge amount of risk and effort of being an entrepreneur is the idea that if you build a successful new business, you can become really rich. And entrepreneurs are arguably the most important people in the economy.
September 19th, 2008 at 12:33 pm
Once the current mess is over, tax the shit out of capital gains for an emergency bailout fund for the next inevitable crisis.
The last few weeks have demonstrated Brooks and McArdle don’t know what they are talking about and are hacks. But some of us knew that already.
inthewoods:
I love the way he just put that on the Clintons without noting that the bill in question was Gramm’s bill.
But regardless – the reality is that if the SEC had not stripped down their requirement of investment banks to maintain a decent leverage (12-1 vs. 60-1), then many of these problems would not have occurred.
Bill Clinton did veto the Bankruptcy bill which New York Senator Hillary voted for once. (Harsh measures for the lower class, bailouts for the connected upper class).
But the fact is the Republicans – who’ve been in power lately by the way – are philosophically against regulations and “big government.” Many Democrats went along with it so it’s not just Republicans.
Brooks is just wrong about “heavily regulated” investment banks. He’s probably lying and has no shame.
Obama had a good line the other day, don’t just fire Chris Cox, fire all of them. Vote out the Republcians.
September 19th, 2008 at 12:38 pm
Without a doubt the leverage was the killer. And that was part of the SEC removing the leverage requirements on investment banks in 2005:
http://bigpicture.typepad.com/comments/2008/09/regulatory-exem.html#more
My point, however, is that without the huge increase in mortgages, none of the other problems exist. So it is root cause, but not the final killer.
September 19th, 2008 at 12:49 pm
vinc,
Interestingly, though, you can’t really explain the observed level of entrepreneurship in terms of pecuniary rewards (meaning the observed risk-adjusted expected return isn’t high enough, particularly if you factor in the decreased marginal utility of money). So a lot of the motivation has to be non-pecuniary (e.g., the autonomy, the creative satisfaction, or so forth).
By the way, obviously there would be a lot less entrepreneurship without people willing to provide capital to entrepreneurs, so even if you designate entrepreneurs as the most directly important people in the economy, that is just another reason to believe the financial sector is also a vital part of the economy.
September 19th, 2008 at 12:51 pm
The information argument against regulation is bollocks. You do not need detailed and situation specific information on individual transactions in order to forbid certain types of risk taking, for example. Ditto reporting requirements, limitations on asset/debt ratios, and so on.
Simple, effective regulation is quite possible. We do not have it because the regulated industries want loopholes and hedges that they can manipulate in order to squeeze out the next little hundredth of a percentage point in profits.
September 19th, 2008 at 12:53 pm
A lot of people are saying that regulation will work – yes, if you write the regulation now, and send it back 10 years into the past. The problem with ‘regulating the market’ is that the market finds ways to make money, given the current regulatory scheme. If they end up taking risks that seem, in retrospect, to be stupid, just postulating that ‘regulation would have caught it’ is absurd.
Very much like driving drunk, running into a wall, and then suing the person who built the wall for damages to your car, because they ’should have made it better’.
Having said all of that, it doesn’t really matter. You can all celebrate – as of 9/15/2008, the free market is dead. Let us celebrate the new era of government-appointed managers and czars of all the industries in America. And let us hope that they are all angels in human form, because if any of them are not, we are all hosed.
Oh, and the commentary on punitive tax rates for the very rich – that’s certainly the way to ensure that there are no rich people in the US – they will all flee to other countries. And in 15 years, you can all lament the permanent doldrums of the US economy, and how frustrating it is that all these other countries are growing like gangbusters, and we’re stagnating, with 10-15% unemployment, little innovation and really good social safety nets – so good in fact, that no feels any desire to work hard at all, and we sail off into a twilight of pathetic irrelevancy.
September 19th, 2008 at 12:57 pm
Njorl,
By the way, there is now a story circulating that the SEC gave out five special exemptions to its ordinary capital requirements in 2004, three of which went to Lehman, Bear Stearns, and Merrill Lynch, allowing those firms to greatly increase their leverage.
So to use your analogy, this would be like the police giving five specific drivers permission to drive at twice the speed limit on the highway, and then three of those drivers ending up causing multiple-car crashes.
September 19th, 2008 at 12:57 pm
Oops–#24 is in the wrong thread.
September 19th, 2008 at 1:00 pm
the flood of foreign investment that fed the credit bubble
Love the wording here: evil, evil foreign investors, recklessly feeding the credit bubble – go away! we don’t want your money! your money’s no good! who do you think you are flooding our wonderful market with your dirty money! damn foreigners!
It’s the new Red Dawn.
September 19th, 2008 at 1:02 pm
Since Halberstam, I’ve considered the phrase to be a reference to people (like the Asian experts in the State Department) who truly are the best and brightest but whose advice is condemned and ignored.
September 19th, 2008 at 1:02 pm
Jerry … I’m with you on State’s Asia experts. Thanks for saying it.
Re: David Brooks, what can one say? A day without David’s musings on any given topic is like a day without chasing your own tail, as you explain to your audience why it is that that very same tail is so maddeningly elusive.
The conspiracy folks are going insane with theories vis a vis the current meltdown. Let’s do some essential triage first and hope the people come to their senses and throw at least some of these bums out of office so that the games may begin anew. Bush looks like an asshole yet again and he’ll look like an even bigger loser tomorrow and the day after that.
September 19th, 2008 at 1:03 pm
The real problem with David Brooks is that given his position as a Times columnist, he might succeed in making some other journalists or even less knowledgeable policy makers think that he actually knows what he’s talking about, rather than ignoring him as totally and obviously out of his depth here.
Regulation can also include opening the books at these companies to the feds and voila, you have a lot of information. To some extent, that has already happened and is happening now.
Here’s my creative thought, as Matt requested:
We should ban all lobbying or political donations on behalf of corporations or industry assocations if we want to fix these problems permanently. We can concede the conservative view that Fannie/Freddie lobbying was a problem, and so is that by the finance industry. I’m sure the Supreme Court would open up some loopholes under the guise of “free speech” eventually, perhaps allowing executives to hire lobbyists personally, but then we can argue about how right-wing and out-of-touch the Supreme Court is.
September 19th, 2008 at 1:56 pm
There should be a rule that if you are pundit and you want to ever again express skepticism about the abilities of the government, you need to at this point express skepticism about the current actions of the Fed. They are making a lot of crucial and expensive decisions very quickly with little consultation and seemingly just to avoid the immediate crisis.
The ink will not be dry of the draft of the new bailout proposal before it becomes urgent for congress to pass it now. How can we believe government acts perfectly in crisis and disastrously when it deliberates?
September 19th, 2008 at 2:09 pm
Some really wierd business is happening with the comments today. They’re disappearing, switching threads, and changing order.
I blame short selling.
September 19th, 2008 at 2:10 pm
How about some sort of requirements of pundits that, if they are wrong X number of times about major issues, they are no longer pundits. Of course, I’m not sure who Fox News would have on the air but I’m sure they could find someone.
September 19th, 2008 at 2:33 pm
You know, having referees at NFL games runs into the well-known problems with adequacy of information. How can the refs possibly predict in advance all the things the players or coaches might do? Enforcing the rules might be nice, but it’s clearly unworkable.
Anyway, Brooks is full of shit, and I’m surprised Matt is discussing him respectfullly. This statement:
The current financial crisis is centered around highly regulated investment banks, while lightly regulated hedge funds are not doing so badly.
is astoundingly ignorant or deliberately misleading or both.
Two of the biggest miscreants were Fannie Mae and Freddie Mac, which, in theory, “were probably the world’s most heavily supervised financial institutions,”
Fannie and Freddit were more victims than miscreants.
In any case, a big reason regulation has been politically screwed up is the thoughtless libertarian-lite ideology Brooks and others have been pushing for decades. (It’s not a coincidence that for 50 years after it was put in place our financial regulation system was stodgy but worked pretty well to create stability, and then starting in the mid-late 80s we get a go-go era marked by big financial blowups every decade or so.). The fact that most of our political and economic establishment was in the tank for Wall Street and thoughtlessly dismissive of regulation is not a reason to be thoughtlessly dismissive of regulation.
September 19th, 2008 at 3:29 pm
David Brooks conveniently ignores (or worse, is ignorant of) the raft of laws and regulations crafted during the Depression to moderate the opportunity for and effects of gaming the financial system.
The only difference between now and then is networked computers. This illustrates the classic bathroom wall quip in the CS departments: To err is human. To really screw things up requires a computer.
September 19th, 2008 at 3:41 pm
cmholm, you could go back farther than that! This whole common law system we have in England will next be able to anticipate all the possibilities. Therefore, we should scrap it and return to anarchy.
All I know is that if this took place next year and President Obama proposed these actions, all you’d hear for weeks would be conservatives screaming socialism and communism at the top of their lungs.
September 19th, 2008 at 3:51 pm
By targeting his ire at unnamed regulation enthusiasts, Brooks manages to somewhat obscure the fact that his conclusion — that we should passively accept the inevitability of crises and the need for post hoc taxpayer bailouts — is totally unacceptable.
That’s his conclusion? I’ve read the column three times now and don’t see any words that even remotely say we should be “passive.” It seems to me Brooks is making the perfectly plausible argument that efforts to strengthen regulation are likely to fail to prevent another financial crisis at some point in the future. In other words, such efforts are likely to fall short of perfection. Is there really any doubt of this? Give me a matchup of smart, Ivy-league law school educated, highly dedicated, resourceful and tenacious government regulators vs. short cut-taking, money-pursuing, greedy bastards (AKA human beings) and I’ll guarantee you the latter will win eventually.
I think a number of regulations are coming down the pike in short order that will make things better (disclosure of and capital requirements for derivatives, for starters); I, like Brooks, just don’t see any human-drafted or human-enforced regulation that will make things perfect.
Brooks isn’t saying no new regulations. He’s saying we should think about some of the deeper issues, because new regulations aren’t enough. And he’s right. But thinking about some of the deeper issues — mostly those revolving around the issue of moral hazard — might risk leading us to conclusions that involve — gulp — some temporary pain in the short term that might make us stronger in the long run. But our government doesn’t do pain, or strong medicine. It knows full well the citizens it governs aren’t interested in such things.
September 20th, 2008 at 3:37 pm
Matt, why would an intelligent person like yourself even bother giving David Brooks the time of day?
Analyzing his byzantine thought process, if you can call it that, is a complete waste of time. He’s not even consistent across time. He makes up “facts” and “trends” to go along with whatever flavor of the day he’s pushing.
Please, spend your time on someone more worthwhile.
September 20th, 2008 at 9:47 pm
We may not know how to regulate, but we still know how to build a guillotine.
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