Working Papers

Rudd and Greed

I have an op-ed in today’s Australian responding to the Prime Minister’s attacks on ‘the culture of greed’:

Scottish Enlightenment philosopher 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.” One cannot explain episodic phenomena such as financial crises with reference to a constant such as human nature or rationality.

The principal mistake the critics of free markets make is to assume that self-interest, greed and irrationality affect only private sector decision-makers. Politicians and regulators are just as prone to self-interested behaviour and do not become saints by virtue of elected or unelected office. The public sector and regulators are populated by the same species that is found in the private sector and financial markets. We should always be suspicious of claims to superior moral virtue coming from politicians.


posted on 28 October 2008 by skirchner in Culture & Society, Economics, Financial Markets

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Great article, if only more of pieces like this were available in the popular media.

I have one concern.

“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 think this is very dangerous ground.  Which is no doubt getting trampled over.

For us to facilitate the re-emergence of these private markets, we first must understand why they’ve stopped trading.

One reason is asymmetrical information.  The erosion of trust between counterparties (not to mention unknown counterparties of counterparties counterparties).

This seems to be what regulators are focussed on.  Rebuilding that trust.  At all costs mind you.

What if there was a stronger reason that these markets have stopped trading?  That reason being, parties no longer have the funds to lend, due to great deleveraging of the financial markets.  Where all parties are deleveraging at the same time.

If regulators come up with ways to restore trust and the real problem is a lack of funds what are the consequences?

-Attempts to restore trust would be impotent in solving the problem.
-Negative aspects of these attempts would still remain.

Now perhaps regulators actually focussed on the problem of the massive deleveraging taking place.  What could they possibly do?
I cant think of anything?  Anything helpful anyway.  The market is demanding less appetite for risk.  Imagine the consequences of ignoring this… again.

Its time to pay the piper.  The pyramid scheme of over leverage and silly risk was sitting on too fragile a base.  Propping it up only increases the chances of making things worse.

ps I messed up and posted this under greenspan was right, so reposted it here.

Posted by .(JavaScript must be enabled to view this email address)  on  10/29  at  04:59 AM

Sooo ... you’re saying what?  That the regulators didn’t regulate enough, or the regulations were wrong?

You can’t seriously be suggesting that CDSs, CDOs etc wouldn’t have been invented (and got out of hand) if there was no regulation of the markets at all.  All these mistakes would have been made by the private markets anyway.

The uncomfortable truth is, there were people (almost all of them lefties) calling for closer scrutiny of (and transparency in) the derivative markets during the early 2000s, and it was always laissez faire types who pushed back against such “regulation”.

This is devasting stuff: Alan Shrugged

Democrats on the committee made Greenspan eat ideological crow. And after the hearing, Democratic Senator Dianne Feinstein of California released letters Greenspan had written to legislators in 2002 and 2003 that now cast the former chief banker as out of touch with financial reality.

Back then, Feinstein was pushing for regulating financial instruments known as derivatives—particularly those called swaps. In 2000, Republican Senator Phil Gramm, then the chairman of the Senate banking committee, had used a sly legislative maneuver to pass a bill keeping swaps free from federal regulation. (Lobbyists for financial firms had helped to write the bill.) The swaps market subsequently exploded, as financial firms bought and sold swaps as insurance to cover their trading in subprime securities and other freewheeling financial products. In a nutshell: the rise of unregulated swaps enabled the growth of the shaky subprime securities at the heart of the current financial crisis. Greenspan was an ardent supporter of keeping swaps virtually unregulated.

In 2001, Enron, having gone crazy with energy derivatives, collapsed—after the firm had manipulated the California electricity market, costing residents of Feinstein’s states billions of dollars. Following that fiasco, Feinstein decided the derivatives market needed to be reined in. As The Wall Street Journal reported in 2004, “When she telephoned Mr. Greenspan for support, he declined, telling her the proposal threatened the multitrillion dollar derivatives industry, which he considers an important stabilizing force that diffuses financial risk.”

In September 2002, Greenspan, Treasury Secretary Paul O’Neill, Securities and Exchange Commission chairman Harvey Pitt, and Commodity Futures Trading Commission chairman James Newsome wrote a letter to members of Congress to note their opposition to legislation that would regulate derivatives. They wrote:

We believe that the [over-the-counter] derivatives markets in question have been a major contributor to our economy’s ability to respond to the stresses and challenges of the last two years. This proposal would limit this contribution, thereby increasing the vulnerability of our economy to potential future stresses….
We do not believe a public policy case exists to justify this governmental intervention. The OTC markets trade a wide variety of instruments. Many of these are idiosyncratic in nature….
While the derivatives markets may seem far removed from the interests and concerns of consumers, the efficiency gains that these markets have fostered are enormously important to consumers and to our economy.
Greenspan and the others urged Congress “to be aware of the potential unintended consequences” of legislation to regulate derivatives.

They got it exactly wrong. Swaps and derivatives ended up undermining, not bolstering, the economy.

Feinstein was not convinced by Greenspan’s argument, and she continued to press for legislation to regulate swaps. And Greenspan continued to resist. In a June 11, 2003 letter—also signed by the new Treasury secretary. John Snow, the new SEC chairman, William Donaldson, and CFTC chairman Newsome—Greenspan praised derivatives and called them an essential part of the economy:

Businesss, financial institutions, and investors throughout the economy rely upon derivatives to protect themselves from market volatility triggered by unexpected economic events. This ability to manage risks makes the economy more resilient and its importance cannot be underestimated. In our judgment, the ability of private counterparty surveillance to effectively regulate these markets can be undermined by inappropriate extensions of government regulations.
They were asserting that government regulation undercuts market-driven self-regulation. But as events have demonstrated, unregulated swaps did not protect Big Finance firms; they weakened the entire financial industry in the United States and overseas.

In a November 5, 2003 letter, signed only by Greenspan, the Fed chair again took a shot at Feinstein’s proposal to control derivatives. He noted that “enhanced market discipline” would address concerns about the manipulation of markets.

Posted by .(JavaScript must be enabled to view this email address)  on  10/29  at  10:55 PM

Good article. Is there any way you could slip in a mention of Mises, Hayek, Rothbard or the Austrian business cycle theory in future articles? It’d probably be considered too radical and controversial though. The idea that a group of heterodox economists have been correctly predicting almost every financial crisis since the Great Depression probably seems quite absurd, on the face of it.

Posted by Sukrit Sabhlok  on  11/07  at  01:09 PM

Actually, I should correct myself. It’s not “since” the Great Depression, because Mises actually predicted the Great Depression of the 1930s!

Posted by Sukrit Sabhlok  on  11/07  at  01:43 PM

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