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Fix Wall Street! But ... How?
Fix Wall Street! But ... How?
By Mark Gimein
Posted Wednesday, September 23, 2009 - 3:41pm
A year after the demise of Lehman Bros., the effort to reform Wall Street is stalled. Why? Simple: Everybody wants to reform Wall Street in theory. But the reality is that the thing we really want to fix—reduce the systemic risk to prevent the kind of domino effect of failing financial firms that we were on the very brink of last year—is the hardest reform to execute in practice.
On the table right now are proposals for a Consumer Financial Protection Agency (a terrific idea) and for a sinle bank regulator to replace the current four (probably a good idea). The first of these can save consumers from getting ripped off by bank fine print; the second, if it gets rid of the Office of Thrift Supervision, will do some good. But neither addresses systemic risk at all. Another proposal would force Wall Street banks to keep some of the securities they create—as Niall Ferguson points out, more or less what Lehman Bros. and Bear Stearns did—and what brought them down so quickly. And then there's the whole bank bonus boondoggle, a likely recipe for more opaque bank compensation schemes and a red herring when it comes to managing bank risks.
There are two issues here. One is that we want an impartial authority that will evaluate the risks of individual bonds (as the ratings agencies failed so badly at doing) and overlapping systemic risks of the kind that became evident with AIG. The reality, however, is that the experience of this crisis should give us no confidence that the next regulator will do any better than the last. Regulators are creatures of the financial system and fall prey to the same misconceptions. The very instruments of structured finance (CDOs and the like) that are at the center of this crisis were developed with the idea of quantifying and controlling risk. Only in retrospect is it clear that they exacerbated it.
To my mind, a second key issue in the regulation of Wall Street is the formulation of policies that will control the expansion of asset price bubbles of the kind that we saw in technology stocks and in housing. What those policies will look like is a major question. But an even bigger one is how willing we are to implement them. In principle we want to prevent these kinds of bubbles. In practice, though, the experience of the last several years shows that we like inflated asset values, and by the time we see that they need to be brought down to reality, it's way too late. We fail to recognize bubbles in the making because, over and over again, we convince ourselves that what we are seeing is not merely a bubble but a new paradigm. Until we get over the unwillingness to be skeptical of these new paradigms and kill these kinds of inflations early on, we will continue to fall victim to the intense boom-bubble-bust cycles that we have seen in the last decade.
