To my earlier posts.
You will see below that Bhide expresses some nostalgia for the regulatory regime of the 1950’s and 1960’s, as he did in his book. However, that period included interest rate ceilings on deposits and banks and savings institutions, and all sorts of restrictions on interstate banking activities. One result was that when interest rates increased, people took money out of depository institutions, and funds for mortgages and small business loans dried up. Neither Bhide nor anyone else calls for reinstating the entire 1950’s regime.
Indeed, as far as I can tell, there is no historical regulatory regime to which you would want to try and return today. I will repeat my challenge to those who blame deregulation for the crisis. If you really believe that it was simply caused by deregulation, then you ought to be able to fix things by simply restoring the status quo to what it was before you think everything went wrong. If you think Glass-Steagall was sufficient, go back to 1998. If you think history took a wrong turn starting with Ronald Reagan, then go back to the banking laws as they stood in 1979.
Nobody actually thinks in those terms. I infer that blaming everything on deregulation is more of a pose than a thoughtful analysis.
Anyway, Bhide’s response to my earlier posts follows:1. I had indeed underplayed the role of politics in two respects. First your hypothesis that the size of banks will simply by virtue of their size allow them to exercise undue influences seems plausible. On the other side large bureaucracies aren’t always as nimble at rent seeking as small prosperous outfits. Regardless its an important issue and one which I hadn’t thought of. On the role of politics in promoting excessive securitization. This I deliberately glossed over, with the knowledge that the main impetus for securitization was provided by the GSEs. There was already too much going on.
2. I fully agree that no regulatory system can be counted on to last forever. (I had made a similar point in discussing the Taylor rule.) Nonetheless there are some rules which are more durable than others (in part because they allow for evolving interpretation.) For instance the Taylor rule vs the prudent man rule. Securities laws vs the tax code etc. I tried to frame my proposal to be more toward the durable end.
3. I argued that diversification ought to be an important complement to due diligence rather than a substitute. Diversification is an important safeguard against mistakes in due diligence or just plain bad luck. So its a good thing to cap exposures to any one credit or investment to some x% of the total. What I argue against is using variance co-variance matrices based on historical data to construct efficient portfolios implicitly relying on diversification as a substitute for due diligence.
4. Large scale, long lived confidence building is necessary for maturity transformation. History suggests (though of course can’t prove) this requires a government guarantee which in turn demands careful examination and oversight. And good examination ought to mitigate the Minsky problem (as I think it did in the 50s and 60s). I think the problem with the current structure is its mixed nature. Some confidence provided by a guarantee, the rest of it is privatized.
5. Finally I just don’t have it in me to blog. A book, an irregular oped or so, and I’m done.
READER COMMENTS
Hyena
Dec 9 2010 at 8:24pm
One problem I had with diversification-as-substitute is that it creates a free rider problem. While a certain percentage of the industry does the diligence, you can get away with it knowing that firms can’t proffer essentially fraudulent products.
I wonder what the tipping point to this is. At what percentage of firms using DAS exclusively do fraudulent originators obtain a clear advantage on the market? From that point forward, their mortgages will start steadily dominating the market either because they offer a better-looking product to securitizers or because they simply have more cash on hand to make new loans (having saved a bundle on underwriting).
Amar Bhide
Dec 9 2010 at 8:30pm
I for one will stand up for the interest rate ceilings that were put in place after the 1933 and 1935 Banking Acts. These were much maligned in the 1980s and 1990s on the grounds that they were anti-competitive.
As a rule competition is an excellent thing — unless it threatens harm to innocent bystanders. Very sensibly, we cap the horsepower of the cars that automobile makers can sell to the public (although cars that are not street legal can be operated on Formula One race tracks).
In banking,I argue in my book, concerns that excessive competition for deposits would lead to reckless races to the bottom in credit standards that would then hurt innocent bystanders go back centuries. After the Civil War, the OCC and clearinghouse associations tried to discourage banks from paying interest on demand deposits because they were concerned that the practice led to reckless lending. In its early years the Fed did as well. The 1933 Banking Act flat out forbade banks from paying interest on checking accounts (and regulated interest on time deposits).
The system ultimately unraveled because the Federal Reserve let inflation get out of hand, making zero interest demand deposits untenable (as entrepreneurs created money market mutual funds that at the outset comprised riskless treasury bills.)
There *was* one serious defect in the 1950s and 1960s rules: restrictions on branching and inter-state banking that made it impossible for banks to mobilize deposits on a scale large enough to meet the credit demands of large borrowers. These restrictions encouraged banks to chase hot money (through instruments such as jumbo-CDs) that wasn’t subject to interstate or interest ceiling restrictions. This was the start of the uninsured shadow banking system, that as we have seen, is vulnerable to collapses in confidence.
So yes, with the exception of restrictions on interstate banking, I WOULD go back to the 1950s rules, interest ceilings and all, PROVIDED we had a Fed that focused, single mindedly,on keeping inflation at zero percent, no ifs and buts (or QEs)
Andrew T
Dec 9 2010 at 9:41pm
Liberalization of capital constraints does seem to be one of the conditions that commonly precedes currency/financial crises. It could be that while the advancements in financial technology that follow liberalization are a good thing, there is a painful adjustment period.
During that adjustment period, we find out how to structure institutions (e.g. contracts, etc) to the new technology by trial and error. The error is of course what causes the pain, some more than others … MBS may wind up fitting this pattern.
fundamentalist
Dec 10 2010 at 12:48pm
Bhide:
And why did the Feds let inflation get out of hand? Because the economy had ground to a halt due to heavy regulation. The Feds were trying to keep it going with low interest, but all we got was high unemployment with high inflation. Carter started the move to deregulation because he could see no other way to get the economy moving again.
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