Redstate

By Pejman Yousefzadeh Posted in Economy | Ill-Considered Regulatory Schemes | The Subprime Crisis — Comments (2) / Email this page » / Leave a comment »

In a period when we are beset with calls for increased regulation as a supposedly surefire way to stop any further financial rough patches like the one we are going through in the wake of the subprime mortgage mess, it is useful and encouraging to note that at least one person has kept his head about him:

Bank loan officers, in my experience, know far more about the risks and workings of their counterparties than do bank regulators. Regulators, to be effective, have to be forward-looking to anticipate the next financial malfunction. This has not proved feasible. Regulators confronting real-time uncertainty have rarely, if ever, been able to achieve the level of future clarity required to act pre-emptively. Most regulatory activity focuses on activities that precipitated previous crises.

Aside from far greater efforts to ferret out fraud (a long-time concern of mine), would a material tightening of regulation improve financial performance? I doubt it. The problem is not the lack of regulation but unrealistic expectations about what regulators are able to prevent. How can we otherwise explain how the UK's Financial Services Authority, whose effectiveness is held in such high regard, fumbled Northern Rock? Or in the US, our best examiners have repeatedly failed over the years. These are not aberrations.

[. . .]

I do have an ideology. So does each member of the forum. I trust our views are subject to the same standards of evidence that apply to all rational discourse. My view of how the efficiency of global capitalism has evolved over the decades as new evidence has appeared contradicts some earlier judgments and confirms others. I have been surprised by the fierceness of investors in retrenching from risk since August. My view of the range of dispersion of outcomes has been shaken but not my judgment that free competitive markets are the unrivalled way to organise economies. We have tried regulation ranging from heavy to central planning. None meaningfully worked. Do we wish to retest the evidence?

Well, evidently some people do. But they forget that regulations like Sarbanes-Oxley haven't exactly had a tremendously impressive track record of success. And they are forgetting the reasons why the subprime crisis reared its aesthetically displeasing head in the first place. Greenspan reminds them:

The core of the subprime problem lies with the misjudgments of the investment community. Subprime securitisation exploded because subprime mortgage-backed securities were seemingly underpriced (high-yielding) at original issuance. Subprime delinquencies and foreclosures were modest at the time, creating the illusion of great profit opportunities. Investors of all stripes pressed securitisers for more MBSs. Securitisers, in turn, pressed lenders for mortgage paper with little concern about its quality. Even with full authority to intervene, it is not credible that regulators would have been able to prevent the subprime debacle.

Read the whole thing. And as always in these circumstances, pray and hope that policymakers do so as well. It could mean the difference between a good decision and a bad one.