Peltzman on the Financial Crisis
By Arnold Kling
Last night, I heard Sam Peltzman talk on the financial crisis. He is known for the Peltzman effect, in which safety regulations (in cars for example) induce offsetting behaviors that increase risk. He described the history of financial regulation in terms of Peltzman effects. I think there is a lot of similarity with my chess game analogy.
Peltzman made a distinction between safety and soundness regulation and what he called operational regulation. I made a similar distinction in Not What They Had in Mind, but what he called operational regulation I called regulation of competitive boundaries. Peltzman emphasized, as I did not, that safety and soundness regulation actually got tougher over the past twenty years. Capital rules were tightened. The FIDICIA act gave the government the power to shut down banks before they became insolvent, when they fell below minimum capital standards. So we did not deregulate financial safety over the past twenty years.
Speaking of FIDICIA, Peltzman thinks that it should have been invoked to shut down Citibank and B of A in 2008. He also thinks that letting Lehman fail was not a mistake. He said, “But I’m just one little guy.” That is how I feel–the ruling class has rallied around the bailouts and around the view that the Lehman failure was a mistake. Peltzman pointed out that because the Lehman failure is being described as a mistake in the standard narrative, the philosophy of bailouts is hard-wired into the thinking of future policy makers, regardless of what might be claimed about the new financial regulation law.
I am thinking of shaping my panel appearance at the same conference around my thesis that the insider-outsider distinction explains more of the political economy of financial bailouts and regulation than does the left-right distinction.