Felix Salmon has an (unsurprisingly) sharp
post on regulating financial markets that includes this observation:
If the purpose of regulation is to avoid market failures, we cannot use, as the instruments of financial regulation, risk-models that rely on market prices, or any other instrument derived from market prices such as mark-to-market accounting. Market prices cannot save us from market failures. Yet, this is the thrust of modern financial regulation, which calls for more transparency on prices, more price-sensitive risk models and more price-sensitive prudential controls. These tools are like seat belts that stop working whenever you press hard on the accelerator.
"The best way to go," continues Felix, "is to set some very clear and simple rules, much as the Spanish central bank did, and refuse to allow banks to build enormous businesses doing things that the regulators don’t understand. "There's a word that's gotten thrown around a lot during the financial crisis: "Innovation." That's the term we've settled on for the financial system's tendency to concoct new ways to package risk and channel money. It is, in American capitalism, a pretty storied term. It's what gave us personal computers and iPods and air conditioners and an economy in a nearly constant state of expansion. In this telling, Collateralized Debt Obligations are just one more innovation. Maybe good, maybe bad, but still a part of America's broadly admirable tendency towards entrepreneurship.The next step -- the regulatory step -- is going to have a lot to do with that judgment. Everyone agrees that no one should be allowed to do this thing again. But no one will. The question is how far you go in constraining the behavior that leads to things like this one. How far you go, in other words, in constraining financial innovation. Salmon is willing to go pretty far: Don't allow banks to build businesses on innovations that regulators don't understand. Conversely, some observers, like this
anonymous Economist blogger, argue that "I'm inclined to believe that whatever innovation our kinetic and energetic innovators come up with is, until proven otherwise, welfare enhancing." That will be the divide. Do you give financial innovation the benefit of the doubt and maybe amp up the government's capacity to "prove otherwise?" Or do you put the burden on Wall Street and force them to prove worth before they can unleash their creations into the wild? That wouldn't be an unknown strategy: It's how the pharmaceutical market currently operates. But it would be a serious change.
By the way: Congratulations go to Felix Salmon, who's taken up shop at
Reuters, and the excellent, train-obsessed,
Ryan Avent, who will be replacing him at
Portfolio.
Felix Salmon has an (unsurprisingly) sharp post on regulating financial markets that includes this observation:
