Monday, March 29, 2010

Folly and "Financial Reform," Part II

In Paul Krugman's column on "financial reform," he makes it sound so simple. Just put, smart, "well-meaning" regulators in power, and they will make sure that the financial system will work just fine.

Unfortunately, while Krugman understands the technical jargon about finance, he really does not comprehend the economics behind it. According to Krugman, government regulators can pick "winners" just as well as anyone else can do, and since capital itself, economically speaking, is homogeneous, well it is pretty easy to run an economy. Just let the regulators decide where the loans shall go, and there won't be any risk, and the economy will work like a clock.

This is fantasy. If government regulators really could pick winners, as Krugman seems to think, then people that wise immediately would be hired by investment firms -- at many times their government salaries -- and lead Wall Street firms into investment bliss. In truth, reality is much more complicated.

If the world Krugman still champions were in existence now, I would not be writing this piece, as laptops -- if they existed at all -- would be much more primitive than they are now. Forget about the Internet, since copper wire still would be transporting telephone calls, and the Internet as we know it could not exist under such technology.

Television would continue to be the dreadful fare of a few network stations, Dan Rather still would be on the air (since there would have been no bloggers to expose his dishonest use of forged documents in a diatribe against President George W. Bush), and the only way to be able to read Krugman would be if one purchased a paper edition of the New York Times. That is because the "shadow" system Krugman so despises, was the system that financed most of the high-technology ventures that have become an integral part of our lives.

Someone like Krugman cannot understand this because in his world, economic outcomes depend only upon how much money the government is willing to print. Whether or not the financial system operated under 1930s rules or if investors were free to pursue the new technologies would lead to exactly the same outcomes, at least where what was available to consumers is concerned.

In other words, Krugman has no concept of the Law of Cause and Effect. To him, the effect always is the same, economically speaking. However, to Austrian economists, the Law of Cause and Effect is front-and-center in understanding economic outcomes.

Austrians understand that the banking system Krugman so praises could not and would not have financed what turned out to be a massive economic recovery during the 1980s. That role was left to the "shadow" system.

Now, most of the deregulation initiatives of the 1980s and 1990s really was re-regulation, and the system became increasingly skewed, as politicians sought to maximize political contributions coming from the financial sector. Unwise laws like Sarbanes-Oxley limited possibilities of profit within our borders, so banks and brokerage houses turned to other means to make money.

While it is easy to decry a lack of oversight when the financial system went ga-ga over what turned out to be toxic mortgage securities, in hindsight, we realize that had the politicians not deliberately shackled the productive U.S. economy, perhaps banks and brokerage houses might have pursued more sound "investments" than pyramiding funds atop mortgage securities that turned out to be worthless.

Furthermore, Krugman forgets that the loose credit policies of the Federal Reserve System helped to trigger reckless lending and touched off an unsustainable boom. (Krugman does not believe booms are unsustainable. He just believes that if a boom slows down, government needs to print lots of money to keep the party going.)

Now, I agree with Krugman that the banks and brokerage houses were irresponsible, but one does not forget that people who believe that the government "has their backs" are going to be more reckless than people who understand that if they fail, they have to pick up their own pieces. Krugman never seems to fathom that the moral hazard created by the government backstops ultimately set the stage for this disaster. Nor is he ever going to change his tune; it's his story and he is sticking with it. I'll stick by my account.


Marco2006 said...

What ever happened to the investigation at Freddie & Fannie? Nothing!

Max said...

Hmmm, reminds me of the safety principle:

It goes like this. Cars hold greater distances to bikers without helmet than bikers with helmet. Likewise violent play is stronger in American Football than in rugby, because they are better protected. This means, the more "safety protection" one believes to have, the more reckless is his behaviour.

I think this sums up the banking dilema quite well.

William L. Anderson said...

That is a very good point, Max. Likewise, whenever we pay for healthcare via "insurance," we operate according to a system of incentives in which we are going to want more services than what we paid in premiums.

Because of mandates, there is no way we can get insurance that will cover just catastrophic events, and we will see even more of the "one size fits all" health insurance as this bill begins to play out.

Anonymous said...

Remember Krugman's cheerleading for a housing bubble?:

“During phases of weak growth there are always those who say that lower interest rates will not help. They overlook the fact that low interest rates act through several channels. For instance, more housing is built, which expands the building sector. You must ask the opposite question: why in the world shouldn’t you lower interest rates?”

Why in the world would someone want the government to encourage investment in something that people apparently do not want to invest in on their own? Isn't THAT inherently risky and unsustainable? Why would a Global Warming fanatic like Krugman insist upon the artificial stimulation of new homes and sprawl?

We must always analyze all "progressive" proposals through the lens of understanding that these people see the great mass of humanity as lab rats in a maze who must be guided by the wise Krugman and his ilk. If one dares to challenge that insecure psychological foundation of "progressives", they will lash out with their typical venom. The particular current "program" devised for the rats may change and evolve over time (see Paul Gottfried) but the psychological motivation of the progressives remains a constant.