Disgraced *john* Eliot Spitzer wrote an op-ed piece in the Washington Post the other day.
How To Ground The Street
The Former 'Enforcer' On the Best Way to Keep Financial Markets in Check
President-elect Barack Obama will soon face the extraordinary task of saving capitalism from its own excesses, much as Franklin D. Roosevelt had to do 76 years ago.
But these are all mere manifestations of three deeper structural problems that require greater attention: misconceptions about what a "free market" really is, a continuing breakdown in corporate governance and an antiquated and incoherent federal financial regulatory framework.
First, we must confront head-on the pervasive misunderstanding of what constitutes a "free market." For long stretches of the past 30 years, too many Americans fell prey to the ideology that a free market requires nearly complete deregulation of banks and other financial institutions and a government with a hands-off approach to enforcement. "We can regulate ourselves," the mantra went.
Those of us who raised red flags about this were scoffed at for failing to understand or even believe in "the market." During my tenure as New York state attorney general, my colleagues and I sought to require investment banking analysts to provide their clients with unbiased recommendations, devoid of undisclosed and structural conflicts. But powerful voices with heavily vested interests accused us of meddling in the market.
Time and again, whether at the state level, in Congress or at the Securities and Exchange Commission under Bill Donaldson, those who tried to enforce the basic principles that would allow the market to survive were told that the "invisible hand" of the market and self-regulation could handle the task alone.
The reality is that unregulated competition drives corporate behavior and risk-taking to unacceptable levels. This is simply one of the ways in which some market participants try to gain a competitive advantage.
No major market problem has been resolved through self-regulation, because individual competitive behavior doesn't concern itself with the larger market. Individual actors care only about performing better than the next guy, doing whatever is permitted -- or will go undetected. Look at the major bubbles and market crises. Long-Term Capital Management, Enron, the subprime lending scandals: All are classic demonstrations of the bitter reality that greed, not self-discipline, rules where unfettered behavior is allowed.
[But what about the fraud, malfeasance, and greed at Fannie Mae? Oh, that's right, still a Democrat first, I guess.]
Those who truly understand economics, as did Adam Smith, do not preach an absence of government participation. A market doesn't exist in a vacuum. Rather, a market is a product of laws, rules and enforcement. It needs transparency, capital requirements and fidelity to fiduciary duty. The alternative, as we are seeing, is anarchy.
One of the great advantages U.S. capital markets have enjoyed over the decades has been the view -- held worldwide -- that there was an underlying integrity to the representations market participants made, because the regulatory framework in which they were made was believed to provide genuine oversight. But as we all know, the laws requiring such integrity are meaningless without a government dedicated to enforcing them.
But these old boxes and formalities still determine how entities are viewed and regulated. It should surprise nobody that capital found the crevices in the regulatory framework. That is what capital is paid to do. But we failed to respond with a regulatory framework flexible enough to plug the leaks.
We do not need additional fragmented areas of federal regulation to handle hedge funds, sovereign wealth funds or derivatives. We need a unified approach that addresses the underlying issues: what kinds of leverage we wish to tolerate, how to measure risk, how much disclosure various trading products should provide.
We began to try to craft such a unified model in New York, as did Treasury Secretary Henry M. Paulson Jr. in Washington last year. But it is urgent that we finish the job. Having flooded the market with cash and seen the government take a chunk of many of our largest financial institutions, we now need to craft the rules that will apply to all market participants.
First, we need better control of systemic risk.
[Oh boy! Systematic risk again. The only way to rid ourselves of this 'risk' is to rid ourselves of 'systems'!]
Second, investors must be protected with adequate, accurate information. Firms must offer transparency both to individual investors and to government regulators.
[Like the banks AND the government not telling us who's borrowing money at the Fed window?]
And third, as Eric R. Dinallo, the superintendent of the New York State Insurance Department, has wisely pointed out, we will have to step back from the current environment in which government has become a guarantor of all major risk. The so-called moral hazard will serve to devalue risk in the market, and this too will have a debilitating long-term effect on capital flows. Only if private actors have to bear the real risks they incur will the market function properly. We are now perilously close to nationalizing risk.
[That's about all I can agree with!]
Here's commentator "ac" from Calculated Risk:
"Those who truly understand economics, as did Adam Smith, do not preach an absence of government participation. A market doesn't exist in a vacuum."
I think sensible critics of the government in recent years have argued that the government's failure has been to act in such a way to promote market excesses rather than restrain them.
In other words, in major national or international crises it seems that the unifying force of easy monetary policy emanating from government agencies is what is coordinating and promoting these extreme excesses.
While it may be popular pressure or special interests that are in some way "forcing" these agencies to take actions that they may think is unwise (as seems to be the case with the Fed in the 1920s), it doesn't fundamentally change the fact that some government apparatus is playing a central role in creating a mass hysteria.
This is what governments frequently do, after all. How is acting to coordinate an unwise bubble any different than acting to coordinate an unwise war?
If we did the latter, why is it unlikely to think we would also do the former if in the short-term it demonstrably provided economic growth?
ac 11.17.08 - 9:05 pm
Indeed, Eliot blames all our financial ills on selfish greed and a lack of *proper* enforcement.
I submit that greed, "for lack of a better word", is merely a function of the stakes. The height of the stakes in our wealthy society is what invited graft and recklessness. Eliot's complaint is one of human nature - which, by the way never changes.
As commentator *ac* insinuates, probably the best we can hope for from Big Government is that it just not feed the frenzy.
That would mean that it should never have been lowering interest rates in the early part of the decade; that it should never have been propping up subprime housing via FHA and Fannie Mae.
The more I think about it, the more I am inclined to believe that we need fewer laws, fewer agencies, and less regulation in the financial world. I'd even take it a step further and propose an end to publicly traded companies.
Because once the MASSES start consuming something - make that anything - (here, investment products) all it does is open the door for MASSIVE government interference.
Click here to read what I've previously written on *john* Eliot Spitzer, aka "Client Number 9".