17 November 2009

Against the Tide of Trick and Trap - Markets Require Transparency and Accountability or They Don't Work.

I recommend this video of an interview with the remarkably articulate and sensible Elizabeth Warren (she is chair of Congress's the bailout oversight board*) in which she explains how to make financial markets work well. Two words - transparency & accountability. At the moment we have precious little of either. And, as she intimates, the two are related. If we have transparency in financial products (say credit cards) then market forces will drive those who offer duplicitous products out of business. But, as she also makes clear, a criterion for federal bailout funds should be (and should have been last year!) that those in charge at the failing financial institutions should lose their jobs and the shareholders in such firms should lose their capital. Ouch! But that is how markets are supposed to work, no? Someone ought to have brought that to the attention of the BushCo officials who were busy insuring that there would be no market discipline on Wall Street. To be fair, the Obama group has not done much better. In any case, the interview is about 19 minutes long, but it is worth watching. The interviewer is James Surowiecki from The New Yorker. (You can find the essay in which Warren first proposed a Consumer Product Safety Commission here. As she says - 'if its good enough for microwaves, its good enough for mortgages.' Regulation-induced transparency, that is.)

For a somewhat different view of the need for reform of financial regulations, here is a short paper by Dick Posner from The Economist's Voice. Posner is correct that Bernanke he is correct too insofar as he thinks that this places the fox in charge of the chicken coop. But imagine what the financial markets would do if Obama came in and cleared the decks and replaced the culpable with someone like Elizabeth Warren! Posner is too quick to blame the government agencies charged with oversight of financial markets for failing to head off the market disaster of the past several years. He is, I think, insufficiently attuned to the extent to which the Federal Reserve, for instance, sees itself as accountable to financial markets. Market players have no incentive whatsoever to be concerned with systemic stability - it is, after all, a public good. This is a point Warren makes nicely. The financial entrepreneurs will devise and sell pretty much any type of flim-flam product they think they can get away with selling. And in the financial markets of late, the move has been to peddle products that systematically occlude the view of buyers, sellers, insurers and regulators - think credit default swaps, securitized mortgages, and so forth - that are meant to undermine transparency. These are products that are, like cigarettes, dangerous when used properly. They are dangerous to the institutional structure of well-functioning markets. And, unfortunately, the only entity with any reason to monitor the performance of that structure is - you guessed it, the government. Unfortunately, though, the foxes remain in charge.
* Officially known as the Congressional Oversight Panel for the Troubled Asset Relief Program (TARP).

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