The Case for Crude Measures
David Brooks had a great column about the problematic relevance of behavior economics to the question of regulation:
If you start thinking about our faulty perceptions, the first thing you realize is that markets are not perfectly efficient, people are not always good guardians of their own self-interest and there might be limited circumstances when government could usefully slant the decision-making architecture (see “Nudge” by Thaler and Cass Sunstein for proposals). But the second thing you realize is that government officials are probably going to be even worse perceivers of reality than private business types. Their information feedback mechanism is more limited, and, being deeply politicized, they’re even more likely to filter inconvenient facts.
I think that makes more sense if you just change the last sentence to say “their information feedback mechanism is more limited so they’re even more likely to filter inconvenient facts.” But I think this is an important point — in just the areas where we’d most like effective regulation, we’re sort of unlikely to get it. If traders are likely to overestimate the effectiveness of their risk models, then regulators are prone to those exact same errors. Where does this leave us?
Brooks, I think, thinks it leaves us just as skeptical of regulation as we were before we took the behavioral turn. I think it arguably leaves us somewhere else. It leaves us with an appreciation of crude measures rather than hubristic efforts to get the regulations precisely right. Until the 1980s, banks couldn’t operate across state lines at all. This didn’t make any real sense. Some states (California, New York, Texas) are much bigger than others either in terms of land area or population or both. And of course New York City is much more integrated with parts of New Jersey (and even some parts of Connecticut) than it is with, say, Buffalo. So whatever the “right” rule was here, this clearly wasn’t it. At the same time, this rule, for all its arbitrariness, has the virtues of being clear and largely self-implementing. It doesn’t depend on anyone’s discretion being used wisely or honestly, and it doesn’t depend on anyone’s calculations being right. And it had the effect of limiting the size of banks so that you never had a really enormous bank failure.
Now that’s not to say we should go back to the ban on interstate banking (I honestly have no idea), but I think it shows the general shape of what we should be looking at. The best you can hope from a regulatory regime is that it will be a satisficing solution wherein some fairly crude rule will improve on the outcomes generated by the unfettered market. When that’s not the case, we may as well let the market go unfettered even though that, too, will be somewhat sub-optimal. But at the same time when we’re looking at a regulatory regime that seems to be working okay, and the regulated parties start saying we need tweaks x and y and z and oh there’s no danger there we should be very suspicious. We shouldn’t count on being to fine-tune our results to perfection, we should either lean in with a heavy hand or else stay away.
47 Responses to “The Case for Crude Measures”
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October 30th, 2008 at 5:18 pm
I’m pretty sure Matt made an entire Wikipedia entry for “satisficing” rather than admit that it’s a typo.
I think I’ll make one up that claims in 2002, the international Anglophone Usage Council decided that any of the spellings of “there” are acceptable for any of the uses of it’s homophones.
October 30th, 2008 at 5:28 pm
I’m not sure this post’s argument is correct, but I’m pretty sure it’s the best post you’ve written this month.
October 30th, 2008 at 5:28 pm
Sorry Matt there never was a ban on interstate banking. You just needed a national charter. And the reason regulators would do it better is because they have no stake in the outcome as such. Traders benefit from understating the riskiness of their model, regulators don’t. The banking system is chugging along well enough given the massive meltdown around due to heavy layers of different regulation using exactly the same risk models traders use.
October 30th, 2008 at 5:28 pm
“we should either lean in with a heavy hand or else stay away.”
The logic which gets you from “satisficing” to “we should either lean in with a heavy hand or else stay away” utterly escapes me.
Simplicity in regulation is a benefit for multiple reasons, but that really isn’t synonymous with “heavy hand” in any meaningful way.
October 30th, 2008 at 5:28 pm
I think it’s possible to have regulations that are not completely arbitrary and fairly effective. Some of the big precipitating factors of our current crisis would have been averted by requiring positions being adequately secured. Whether it be putting 10% down on a house or collateral for CDSs written. Some speculation is necessary for proper functioning markets – but if people can take huge positions without putting down a significant financial stake the bubbles can get truly enormous. I think there are ways of regulating without imposing very significant, unnecessary costs.
October 30th, 2008 at 5:34 pm
“I think it arguably leaves us somewhere else. It leaves us with an appreciation of crude measures rather than hubristic efforts to get the regulations precisely right. ”
This might be the smartest thing you’ve ever written. It is certainly worth exploring much, much more.
October 30th, 2008 at 5:34 pm
Regulation based on the premise that in many circumstances the regulated parties have ample reason to lie and conceal, rather than on the premise that regulated parties naturally operate in a socially beneficial manner, may be a good starting point. All of Brooks’ feathery stuff about nudges and behavioral economics is window dressing and blather.
October 30th, 2008 at 5:35 pm
There are two obvious problems in Brooks’s comments.
First, he assumes that the problem is in the failure of the markets to act in their own self interest. The larger problem is when the self interest of the actors in the markets and that of the investors do not align. It makes perfect sense for traders to risk losing almost nothing of their own for a possible tremendous gain if the gambles pay off. Only the investors stand to lose something. This is part of what has to be fixed.
Second, he asserts that all government officials are hopelessly politicized. It seems to be widely recognized that this is a Bush/Cheney innovation. These jobs were once granted based on competence, not ideology. There is no reason to think that these positions must remain politicized after Bush exits.
October 30th, 2008 at 5:42 pm
Satisficing sounds like something W. would say. Like “internets.”
If firms are “too big to fail” – meaning that if they fail, they bring down the economy, they need to be regulated more.
Regulators need to make sure they are not overleveraged, or, failing that, tax them enough during the good times, so that the money could be used to provide credit and liquidity in bad times.
October 30th, 2008 at 5:43 pm
Matt’s on the right track. It’s close to hopeless to try to hire federal regulators who understand the most sophisticated financial instruments. How can you pay them enough compared to Wall Street?
What we should have done was use simple regulation at the bottom of the chain of financial catastrophe: home mortgages. The government should have required 10% down payments on home purchases (and no taking out second mortgages to pay the 10%). That single regulation would have prevented the Housing Bubble. That’s simple enough for any GS-whatever federal regulator to understand.
October 30th, 2008 at 5:47 pm
Then, as David says above, impose some very simple regulations on sophisticated financial instruments analogous to the 10% down payment rule on mortgages to force players to have some skin in the game so that they’ll look out for their own interests.
What we need is not 5000 pages of regulations in the Federal register, but one page regulations that home in on the key chokepoints.
October 30th, 2008 at 5:48 pm
Another problem with Brook’s column and Matt’s parsing is that markets and government officials do two different things, and they achieve their positions in different ways.
Traders in the market want to make a profit. They usually hope to do that by buying and selling, but it doesn’t matter much to them what they buy and sell. If they make money, they probably stay in the market, if not, they change jobs.
Government officials are supposed to do what their job description says, and in our country that means it’s dictated overall by the legislature. Certainly, there has been a distressing tendency to declare that government needs to be responsible for making capitalism work, because, as we are constantly told, capitalism is the source of our wealth.
It would be possible, however, to simply short-circuit this and make good government the source of our wealth. We’re not doing that right now, though, so vaguely asserting that government officials are as prone to error as free marketeers simply has no relation to what these actors actually do.
October 30th, 2008 at 5:53 pm
Brooks is totally full of shit. This is what happens when you allow the national debate to be conducted/monopolized by demonstrated ignorant morons.
The engineers of this country put men on the fucking moon and got them back. Because they didn’t allow themselves to engage in liberal arts deceit about reality. Nor were they so fucking corrupt that they devoted 8 hours a day to corrupt self-interest instead of to the mission.
Airline pilots of this country fly hundreds of thousands of flights every year –and land the goddamm planes safely. Military officers conduct high risk operations in peace and in war — and bring many of their men back alive while securing victory.
Brooks column is infuriating because he’s bound to be smart enough to KNOW that he’s lying to the country. This financial disaster was NOT an accident — it was the product of deliberate irresponsibility and corruption.
Every damm Republican Member of Congress deserves to be thrown out of office. They actually deserve far worse, in my opinion. So do Democratic members of the Banking Committees who kept quiet. Barney Frank and Chris Dodd ,especially.
But Brooks’ sees his job as lying to the country so the Republicans and whoring Democrats can evade accountability. ANd the New York Times sees its jobs as ..well.. to kiss the ass of whatever richs interests will pass it money. It sure as shit sees no obligation to serve its readers with the Truth.
October 30th, 2008 at 6:02 pm
I find it really disturbing that we say that the banks have grown to big to be allowed to fail, but then we help them buy one another, thus growing larger.
October 30th, 2008 at 6:02 pm
How can the government pay enough? Easy, have the Fed do it. Sure they still won’t get 8 figure salaries but I’m sure you can find those willing to work for only 7 figures but mostly 8 hour days.
October 30th, 2008 at 6:09 pm
Bush spent 2002 through 2004 denouncing down payments on home purchases as the chief barrier to his goal of adding 5.5 million new minority homeowners by 2010. That sent a clear message to federal regulators (who all work for Bush) to not take away the punchbowl as the party got interesting. It was all part of the Bush-Rove plan to win the Hispanic vote for Republicans by making Hispanics into prosperous homeowners. Thus, the amount of mortgage dollars going to Hispanics for home purchases went up 691% from 1999 to 2006 according to the federal database, compared to about 100% for non-Hispanic whites.
Anybody who wanted to regulate the mortgage industry would be guilty of trying to take the American Dream away from minorities.
October 30th, 2008 at 6:10 pm
We’ve just had the credit swap/derivatives collapse shouting in economists’ ears: Punked! And yet we’re supposed to believe that government regulation — demanding the revelation of brokers’ exposure to credit swaps and derivatives — would be inherently worse. In other words, there’s no hope and we should head to the street with guns.
October 30th, 2008 at 6:10 pm
The corruption really begins in the Liberal Arts Departments of our universities. You get a bunch of bright kids, get them piss away 4 years and $200,000 on gaining a degree — and then let them know what their life’s work really is.
That if they want even a middle class life, they will need to apply all the “arts” they learned in the service of rich employers. How to create convincing lies and deceitful narratives. How to disseminate misleading sophistry with graceful wit and elegant prose. How to betray every ideal in the Western Canon.
Our universities get hundreds of $Billions from the taxpayers every year — and tax-free endowments. And they don’t do a damm thing in return. That’s why, in my opinion, the alarm over this mess was sounded two years ago by a professor at NYU — not by the Ivy League.
October 30th, 2008 at 6:17 pm
From 1932 to 1980 we operated this country’s banking and financial systems with competence.
The S&L scandal and 1987 panic happened on Republican Reagan and Republican George H Bush’s watch. Just as this disaster is happening yet again under a Republican President. And in those cases, the cause was the same: Republican corruption undermining regulatory regimes.
October 30th, 2008 at 6:20 pm
Hmm, whatever happened to ‘perfection is the enemy of the good’?
As for regulation, I think the bar is pretty low at the moment. I think Drum’s cats could have guessed 60 trillion of under-secured credit default swaps was a mistake.
And speaking of low bars, it seems that Texas actually avoided the housing mess because they had better regulations on mortgage brokers. Shame on elsewhere.
October 30th, 2008 at 6:22 pm
Re Steve Sailer’s comment “Bush spent 2002 through 2004 denouncing down payments on home purchases as the chief barrier to his goal of adding 5.5 million new minority homeowners ”
—————
The “chief barrier” to people getting homes is that the Republicans controlled the three branches of government and were dedicated to shoveling as much of the national income to the 3 percent richest part of the population as they could.
Counter Republican Redistribution of income with a liberal redistribution of income and people could afford to make their mortgage payments.
Look at the goddamm facts, for christ’s sake:
http://en.wikipedia.org/wiki/Image:United_States_Income_Distribution_1967-2003.svg
October 30th, 2008 at 6:26 pm
Don, I would have taken umbrage at your liberal arts tirade a few weeks ago, but I have to admit that English Lit major Paulson has brought shame to the clan. But I think we need to blame a few Nobel Laureate physicists who screwed up the risk analysis. I also think more than a few B-schoolers need to be shot, but maybe I am over reacting.
October 30th, 2008 at 6:39 pm
If you look, by zip code, at where the foreclosures and collapses in home prices happened the most, you’ll see that, surprisingly, the Housing Bubble shoveled a gigantic amount of cash into hands of the working class. The idea was that the top 3% would end up holding all the pieces of paper with IOUs writte on them, while the masses were kept happy with McMansions, big screen TVs, rims, and trips to Las Vegas, all paid for with IOUs.
A foolproof plan!
For example, the hardest hit zip code in Los Angeles County, the nation’s most populous with 10 million people, is Lake Los Angeles, out in the dusty high desert, where there ain’t no lake, ain’t no Los Angeles, and sure as hell ain’t no Lake Los Angeles. (The artificial lake dried up decades ago.) In Q3-2008, almost 5% of all the homes in that zip code entered foreclosure. That’s a working class area about 50% white, 30% Hispanic, and 15% black.
The plan of both the Clinton and Bush Administrations was to boost the homeownership rate from 64%. They got it up to about 69%, so the marginal homeowners came primarily from the 2nd quartile — not the poor, but the people scraping by trying to keep their kids away from the poor.
Unfortunately, there weren’t any trends or policies that would enable those marginal new homebuyers to ever earn enough money to pay off those big new mortgages, so everybody ended up being hosed.
October 30th, 2008 at 7:22 pm
Re Sailer’s comment “If you look, by zip code, at where the foreclosures and collapses in home prices happened the most, you’ll see that, surprisingly, the Housing Bubble shoveled a gigantic amount of cash into hands of the working class.”
————–
Newsflash, Steve. If you sucker someone into putting equity into an overpriced home via an ARM w/ balloon payment — and then foreclose on the poor sonabitch a few years later –so that he loses his equity — you have NOT been “shoveling a gigantic amount of cash into hands of the working class” — you have been running a loan shark operation with a Big Con variation on Wall Street.
And last time I checked, that $1.5 TRILLION that Bush and Paulson just stole from us ain’t going into the hands of the proletariat. It’s going into the hands of people who –by the merest coincidence — dumped a shitload of money into both political parties.
Viewed in that light, campaign donations in the $200,000 class are earning a return of around 10,000 percent.
October 30th, 2008 at 7:28 pm
Eric Maskin has a letter in the Times today making the case that the bankers were actually being rational, and we don’t need behavioral economics to understand what’s going on. Which, as he points out, makes the need for effective regulation even greater.
October 30th, 2008 at 7:38 pm
It’s close to hopeless to try to hire federal regulators who understand the most sophisticated financial instruments. How can you pay them enough compared to Wall Street?
Off the top of my head, Brooksley Born at the Commodities Futures Trading Commission tried to bring regulation to credit default swaps in freaking 1997 because she understood enough of what was going on to realize these people needed minding. So, give me a freaking break.
surprisingly, the Housing Bubble shoveled a gigantic amount of cash into hands of the working class.
Uh, not so surprising. Wages weren’t growing for damn near a decade, as all GDP gains (including those financed by massive deficit spending) got funneled up to the investor class. So, working people got trickle-down easy credit (anyone else remember Alan Greenspan exhorting us all to pick up ARMs?)
It ended up being 21st Century Bread and Circus.
And, unsurprisingly, when the bread and circus loans got called? The people who hadn’t seen a raise in a decade couldn’t pay ‘em back. And then the whole house of cards began to tumble.
October 30th, 2008 at 9:23 pm
The current foreclosure rate wouldn’t have done spit to the economy without the insane margin purchases of the credit swap industry. The foreclosures are the occasion of the collapse, not the cause.
October 30th, 2008 at 9:34 pm
“Our universities get hundreds of $Billions from the taxpayers every year — and tax-free endowments. And they don’t do a damm thing in return. That’s why, in my opinion, the alarm over this mess was sounded two years ago by a professor at NYU — not by the Ivy League.”
I’m sorry, Don Williams, but this comment is dense. The vast majority of “Federal funding of universities” (except in the case of public universities, which I don’t think you’re talking about here) is funding for research projects (new materials, biological research, new technology, etc), not for “Liberal Arts Departments”.
Indeed, I don’t understand the connection here between “liberal arts departments” and corruption. It’s worth noting that a high percentage of the people behind engineering these faulty risk models and exotic financial instruments like CDOs were actually quantitatively trained physics/math majors who, in our poor funding environment, figured they could make a better living on wall street than contributing to scientific knowledge.
October 30th, 2008 at 11:14 pm
The most powerful and general point in this post is the value of simplicity in regulation (and by extension, law). Fewer and simpler regulations can be more effective and offer less room for corruption.
Today, the sheer mass of regulations is awesome, an accretion left by decades of behind-the-scenes politicking and deal-making. Because the result is enormously complex, only specialists can make sense of it and loopholes are easy to make and hide.
The fight against corruption must also shovel away the stinking heap of dung it has made.
Increased government transparency — a major Obama objective — fits well with this objective. Internet-based mobilization of lawyers and ordinary citizens will shine light into the darkness of the newly exposed holes, which will no longer be such good hiding places. More eyeballs watching government will expose not only bad actors, but bad institutional and regulatory structures. With more brains applied to the problem, and a network of mobilized activists advocating for the solutions, it may be possible to formulate and implement the simpler, more effective, and less corruptible systems we need to make government serve the people and address burgeoning world problems.
October 31st, 2008 at 7:26 am
As per a NYT article, in the current collapse, the banks have lost $1.06 for every dollar they made during their boom years. This is no golden goose. Kill it!
October 31st, 2008 at 1:12 pm
A good thought provoking piece. I wonder though if the fact that government usually should make judgments openly and outsiders can comment acts as huge plus. I would have to exclude the Bush period but that makes my point even more strongly. Government can be prevented from working properly by secrecy.
November 1st, 2008 at 12:16 am
First, yes, the term is satisficing, from satisfice, decide on and pursue a course of action satisfying the minimum requirements to achieve a goal, because the more normal satisfying had already been taken in the formal arena for satisfying any criteria, including an optimizing criteria, so it was too generic when Simon needed a more specific term.
Second, yes, regulatory rules that provide gross tuning are superior to efforts at fine tuning, because a core problem for central control is information overload. Miller described the intrinsic character of the problem in Living Systems Theory in 1978, so it only taking four decades to occur as a new discovery seems a pretty good pace of advance.
December 3rd, 2008 at 3:14 pm
DALLAS, TX — 11/17/08 — Ed Butowsky , who has been recognized by Reuters as one of the Top Financial Advisors in the World, and whose multiple speaking appearances include The Yale School of Management, The NYU Stern School of
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