Categories:
Political Economy
Financial markets will always be subject to miscalculations and mistakes. However, the more we ask politicians to provide perfect insulation from financial risk, the more fragile the system will become. That is the real lesson we should take from the Fannie and Freddie saga.
Read the whole thing. It is counterintuitive that markets are better than government at providing collective benefits. It is also counterintuitive that a top-down design process can yield a more fragile structure than an emergent decentralized process.
READER COMMENTS
shayne
Jul 25 2008 at 11:05am
Excellent article – thank you.
Can you provide some insight – even speculation – as to why it was considered preferable to create/redefine the GSE’s as limited regulation entities rather than simply reducing the regulatory burden on thrifts during the late 70’s/early 80’s?
From your article, the sole weakness with the thrift system that the GSE’s addressed was their relatively local rather than national reach. That also seems to be an artifact (exclusively) of over-regulation.
jb
Jul 25 2008 at 12:48pm
In software circles, it isn’t counter-intuitive that a top-down design process is more fragile, at least not any more.
I’ve been working in software for 15 years, and this phenomenon is manifest in the classic ‘waterfall’ (top-down) model of software development. The newer ‘agile’ method uses a less structured, more individually independent model, which tries to deal with exactly the issues you mention.
But I do think that, for whatever reason, most people believe that a carefully-built, well-thought-out system will always beat a messy, chaotic, self-organizing one. Most people have been submerged in the cult of the expert for so long that it is second nature to accept the vast and mysterious powers of expertise.
In software, at least, however, you can only be beaten with the ‘this top-down software is too inflexible’ stick so many times before you start to look for different strategies.
Arnold Kling
Jul 25 2008 at 1:17pm
Shayne,
In the 1970’s, one of the most important regulations was regulation Q, which limited the interest rate that thrifts could pay depositors. It was like a state-enforced cartel for thrifts, so it was hard to get rid of. In 1970, it was easier to create Freddie Mac than to get rid of reg Q. Finally, when deposits had shrunk by enough, the thrifts were desperate enough to allow reg Q to be eliminated, in exchange for getting some very generous regulation that allowed them to stay in business even though they were insolvent. That scheme finally collapsed around 1980.
PrestoPundit
Jul 27 2008 at 1:17am
Hayek said the more governments plan the harder it is for every individual to plan. This looks like a subset of this general principle.
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