30 October 2008

No wiser after the event

I'll state my biases up front and declare that the problem comes down to the whole notion of "packaging" or "bundling", whereby high-risk housing loans were presented as low-risk collateralised debt obligations through sleights of hand. Ratings agencies are to blame here, as is the sheer sloth of the institutions involved - if just one had challenged the idea that a CDO made up of high-risk loans could not seriously be classified as a low risk bundle/ package/ other, it would have been a triumph for the lawyers concerned and the whole business could have been unwound in a much less messy way than has come to pass.

Richard Clapton sang "we search for leaders on our hands and knees", and searching for answers on the economic issues besetting the country and the world is little more elevated. However, I do know bullshit when I see it and Stephen Kirchner has helped put some of the problems in clearer perspective, however unintentionally.
In the world according to the Prime Minister, "this culture was never challenged by a political and economic ideology of extreme capitalism". The credit crisis "bears the fingerprints of the extreme free-market ideologues who influence much of the neo-liberal economic elite".

The Prime Minister almost sounds like a conspiracy theorist, blaming the world's problems on shadowy elites and greedy capitalists. Unfortunately, Rudd is not alone in this. Politicians across the world have been quick to point the finger at financial markets and the executives who preside over financial institutions. Even US Republican presidential candidate John McCain has sought to blame Wall Street, which he describes as a casino.

It's one thing to quote someone selectively, but it takes breathtaking stupidity Kirchnerian skill to miss the point of the selective quotes that are used: well, half of them anyway. Rudd was having a go at the US financial markets as well as the US regulators. This includes not only elected members of Congress but also those who work for public-sector agencies charged with regulating the US financial system. Congress passed lazy, watered-down legislation. Regulatory agencies were slow to detect, let alone pursue, breaches of the law. The Administration of George W Bush and the Republican-dominated Congress for much of his term discouraged enforcement of such regulations that there were in the financial markets.

Kirchner could only have supported such a tame approach to financial sector regulation. Do you really want a vigilant set of regulators, Stephen, and would you support a tax system that paid for such? What if there were Congressional hearings in say 2005, with Senators McCain and Obama railing against shonky debt instruments, when neither of them had any experience with the finance sector? What if Richard Fuld or some of the clowns from Bear Stearns (remember them?) had gone to prison around that time? Stephen Kirchner would have been the first to condemn such heavy-handedness by the dead hand of the state (actually, he would have followed closely behind otiose Washington gossip queen Grover Norquist).

What if an Australian financial institution, as recently as last year, had refused to participate in packaged/ bundled/ other shonky debt instruments? Stephen Kirchner would have condemned them as Little Australia protectionists, out of step with the wider world, you just don't get it do you.
It is not surprising that politicians seek to scapegoat capitalism in general and financial markets in particular. Capitalism and free markets have always been objects of popular suspicion, even in a notionally free market country such as the US. Politicians pander to these popular prejudices, not least because focusing attention on supposed market failures diverts attention from their own policy failings.

Here, Kirchner tries to pretend that a recent fundamental philosophical turning point underpinning the interoperation of markets and government did not take place. Alan Greenspan admitted that he overestimated the self-interest of institutions as a mechanism for market self-correction. Greenspan effectively admitted that it was not the regulations themselves, not even the regulatory environment that he had helped create, but the very idea that markets contain self-correcting features (in which Kirchner clearly still believes).
On the one hand, capitalism is accused of elevating self-interest above all other considerations, such as altruism. On the other hand, we are also asked to believe that financial market participants are driven by irrational sentiment that ultimately harms their own interests.

Whatever one's view of human motivation and individual rationality, one needs to make consistent assumptions about human behaviour. People are not altruistic or rational one day, then greedy or irrational the next.

Kirchner underestimates just how many examples there are in both of his "hands", and if he regards this as a paradox then perhaps he has framed his argument wrongly. Wait till he discovers that individuals can be greedy on occasion and altruistic on other occasions! Wait until he confronts the idea that an action can be interpreted as both altruistic (helping poor folk buy their own homes) and greedy (people sucked into obligations they can't afford; financiers "packaging" a high -risk debt as a low-risk one) at the same time.

How does Stephen Kirchner deal with the paradoxes of the modern world? Hurtle back three centuries into the past:
David Hume noted as long ago as 1741: "Avarice, or the desire of gain, is a universal passion which operates at all times, in all places and upon all persons."

In 1741 the beaver-fur traders of Wall-street did not have the clout to depress markets for credit and real estate in Edinburgh. Hume can be excused for not addressing the issues of 2008, Kirchner cannot.
The advocates of free markets seek to make consistent assumptions about human behaviour and argue that all people respond to incentives. Good people can be led to do bad things and bad people can be led to good things, depending on the institutional setting in which they are located. If we are distrustful of the motivations of people in the private sector, we should be just as wary of the motivations of those in the public sector, not least because the latter have considerably more power over the rest of us. Their mistakes can consequently prove much more costly.

This is sheer intellectual laziness, an unfounded and unsupported assertion. It sounds more like a statement of religious faith, a lunge for solid truth amid a swirling, churning and frightening reality, which might explain why Catallaxy people snarl at you for daring to question a fatuous statement like that.
What we need are institutions that are robust to the inevitable errors of public as well as private actors.

Any ideas? What do you mean, no?
The routine violations of perfect competition are often viewed as automatically justifying government intervention to correct market failure. The inevitable violations of the efficient markets hypothesis also have been used to argue that free markets deliver inefficient outcomes, without bothering to establish whether proposed regulatory interventions are likely to improve on these outcomes.

The best way to guarantee 'perfect competition' is to be transparent about who you are and what you're doing. Most corporate regulation since the 1980s has been geared around this principle: be transparent, disclose up-front, use disclaimers. In the past ten years or so there has, in Australia and the United States, been little in the way of high-level thinking about corporate regulation. Instead, there has been a kind of urban warfare over individual clauses, played out not in open court but by lobbyists in backroom deals. Kirchner would be wrong to blame politicians and regulators for this phenomenon, except insofar as they did not tell the lobbyists of free-market champions where to get off.
Governments and regulators for the most part rely on the same information and the same methods for analysing that information as the private sector. This is why regulators and governments are no better at avoiding mistakes than the private sector.

This does not follow logically at all. It is possible for two parties to have access to the same information and for one party to make better (however you might quantify that) use of information than the other. Again, this is a statement of faith.
But the private sector has the distinct advantage of a focus on the bottom line. This is a powerful incentive to avoid mistakes, but only when the costs of those mistakes are borne privately rather than publicly.

Have you learned nothing from the failure of Bear Stearns, Lehman Brothers, Northern Rock? Nothing? Such companies cannot be said to fail privately. Perpetrators of such all-encompassing failure cannot expect, cannot demand to have their yearning for privacy respected. If a thief who steals $100 is tried in open court, so too the fool who sends a company, an economy down the tubes must be examined publicly, if for no reason other than this does not happen again, that actions have consequences. Can the man who flaunts his wealth credibly seek privacy?
Markets also have the advantage that they are self-correcting.

No, Stephen, they do not. No correction is possible in the current market without government intervention. This is not an assertion of faith, it is a shriek of denial.
Falling US house prices are the market's way of correcting the oversupply in US housing. US house prices began responding to this oversupply well before the problem was recognised by regulators or by government.

The US housing market is not in equilibrium, and any disequilibrium cannot be sheeted home to government.
In credit and other financial markets, the present crisis can be interpreted as a global re-pricing of risk following an extended period in which risk was incorrectly priced. Again, no government or regulatory intervention was required to set in train this market correction. We may not like the price signals generated by markets in the context of the credit crisis, but that does not mean the market is not working or the price signals are wrong.

Yes it does actually. It isn't just the price of credit that's the issue. Australia has not engaged in subprime lending to the extent as has happened in the US, yet Australian lending has not only been repriced but actually restricted. The whole idea of the US government's intervention was not just that credit would be repriced but that the supply of credit between institutions and within the market would actually dry up. Please understand this Stephen: government, politicians and regulators, have stepped in to avoid market failure.
If there is a role for government, it is in facilitating the re-emergence of these private markets, without crowding them out or standing in the way of the market adjustment process.

I love the arrogant assumption behind the If there. It's a straw man to expect that regulators are seeking a non-market solution, or to "crowd out" such market as remains. Such an assertion also puts the finance market in breach of one of the fundamental laws of both politics and economics: beggars can't be choosers.

This is why you work to avoid market failure: the alternative is the humiliation of being regulated by government. CIS does the market no favours by seeking to remove this threat.
The financial crisis is as much a failure of regulation and government intervention as of markets and should be a humbling experience for governments and regulators, no less than for market participants.

Market participants have the consolation of bonuses, even in the face of catastrophic failure, which is not open to government employees. Sometimes you just have to cop the superiority on the chin. If resentment of this treatment avoids market failures going forward, so much the better.

Stephen Kirchner is an intelligent man wedged in an ideological crevasse. The idea that government has no role to play in the global financial crisis is nonsense, as is the idea that it must be more respectful to those who have led us here. The CIS and all of its research fellas should be adapting their ideology to fit current and foreseeable reality. Peter van Onselen tried to do this; he only had the thin intellectual soil of the Liberal Party to work with he had almost set himself up for failure. Kirchner, with the Lost Boys of the CIS and Eye Pee Yay to draw upon, has no excuse for embarrassing himself so publicly.

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