Strengthening Constitutional Self-Government

No Left Turns

Time to get serious

Mort Kondracke thinks so, and judges Barack Obama’s early response to our financial crisis to be the more serious of the two candidates’.

Like John McCain, I’m no expert on economics, but I know a thing or two about virtue. Kondracke wants the government to save us from ourselves, which is, one might say, the forte of contemporary liberalism.

But there is, I think, a more fundamental problem. All of these investment banks became "creative" in their undertakings because their customers--us--weren’t satisfied with relatively small returns on their investments. It doesn’t take a rocket scientist--or an economist--to understand that high returns generally come with high risks. If we could have been "satisfied" with more modest rates of return, instead of expecting that we could earn in the double digits on our investments, perhaps the investment bankers wouldn’t have gone so far out on a bunch of very shaky limbs. But sobriety in our financial expectations requires sobriety in our personal lives, at the very least, the classic bourgeois (and not even heroic) virtue of living within our means.

John McCain could talk about that, even though it would be (in some respects) an "un-Republican" thing to do.

Update: Or rather, backdate: I see that Julie has already stated more or less the same view below (too lazy to link).

Discussions - 7 Comments

Maybe others don't force themselves to try to read the NYT. ">">http://freakonomics.blogs.nytimes.com/2008/09/18/diamond-and-kashyap-on-the-recent-financial-upheavals/"> This piece on the financial storms may be of general interest.

This sounds like "People act like people and the invisible hand smacks them around a little." Government trying to save us all from economic pain has got us in this mess in the first place.

It could be worse. At least we do not live in Russia, which takes over businesses in other ways and for other reasons.

It is interesting that these people can tell you why this happended right away. We believe that these people had a better understanding than the captain's of industry? This is all a scam built on a giant Ponzi Scheme with the goal of crushing the American Economy in order to slowly crush the people's inhibitions to the new world order agenda of one world government and the surrender of american liberty.

First they sap and impurify all of our precious bodily fluids, now this.

Jos. K.: I utterly disagree with your claim that banks became creative because "we" sought higher yields. The seeds were the Greenspan-induced low Fed interest rates, done to get us over the busted Tech bubble; and the securitization and sale of pooled mortgages to buyers around the globe. Bottom line is that risk can be spread (shared) but not eliminated.
The Fed basically seduced almost everyone to borrow. That led to excessive borrowing (over-leverage) to buy illiquid assets for which no decent market system existed...so how much is my CMO worth? Don't know...so how do we price it? Don't know....

I agree with your common sense observation...I would rephrase it as a principle: Money not lost is money earned. I enjoyed Steve Thomas's link to freakonomics and recommend Alan Greenspan's article: The Role of Capital in Optimal Banking Supervision and Regulation. my computer won't let me link properly so: http://www.ny.frb.org/research/epr/98v04n3/9810gree.pdf or google it.

"First a reasonable principle for setting regulatory soundness standards is to act much as the market would if there were no safety net and all market participants were fully informed. For example, requiring all our regulated financial institutions to maintain insolvency probabilities that are equivalent to a triple-A rating standard would be demonstrably too stringent because there are very few such entities among unregulated financial institutions not subject to the safety net. That is, the markets are telling us that the value of the financial firm is not, in general, maximized at default probabilities reflected in triple-A ratings. This suggest, in turn, that regulated financial intermediaries cannot maximize their value to the overall economy if they are forced to operate at unreasonably high levels of soundness."

"Nor should we require individual banks to hold capital in amounts sufficient to protect fully against rare systemic events, which, in any event, may render standard probability evalution moot. The management of systemic risk is properly the job of the central banks. Individual banks should not be required to hold capital against the possibility of overall financial breakdown. Indeed, central banks, by their existence, appropriately offer banks a form of catastrophe insurance against such events.

Conversely, permitting regulated institutions that benefit from the safety net to take risky positions that, in the abscence of the net, would earn them junk bond ratings for their liabilities is clearly inappropriate. In such a world, our goals of protecting taxpayers and reducing the mis-allocative effects of the safety net would simply not be realized. Ultimately, the setting of soundness standards should achieve a complex balance-remembering that the goals of prudential regulation should be weighed against the need to permit banks to perform their essential risk-taking activities. Thus, capital standards should be structured to reflect the lines of business and the degree of risk taking chosen by the individual bank."

Supervision and regulation can never be a substitute for a bank's own internal scrutiny of its counterparties and for the market's scrutiny of the bank. Therfore, we should not, for example, abandon efforts to contain the scope of the safety net or to press for increases in the quantity and quality of financial disclosures by regulated institutions.

"If we follow these basic prescriptions, I suspect that history will look favorably on our attempts at crafting regulatory policy."

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