Another regulatory alum chimes in. On Wednesday, former New York Fed chief and current Goldman, Sachs & Co. (they're everywhere!) risk macher Gerald Corrigan weighed in with a load of mostly sensible proposals under the aegis of the felicitously named Counterparty Risk Management Policy Group. Corrigan's group has been worrying about the situation for a while now, particularly about CDOs and credit derivatives, proof of sorts that not everyone was gulled by the fancy stuff. The problem with the reforms tossed out, as The Wall Street Journal reported, is that while everyone is frantically bailing, no one has the time or the budget to make these changes. Collective action, meaning regulatory action, needs to be taken because individual firms won't do it themselves. This is the very essence of why we have regulation in the first place.
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But Corrigan made one comment worth pondering, if only because it aligns with positions taken over the last few days by iconic former Fed chief Alan Greenspan and former Securities and Exchange Commission Chairman Arthur Levitt (see Levitt, Greenspan and the limits of regulation). "The root causes of this crisis ... is actually to be found in collective human behaviors," he said. "No one is smart enough to anticipate what are the key turning points in the collective human behavior." Corrigan agrees with Greenspan and Levitt that in the face of bubbles, regulators are essentially helpless.
Don't tell the children! (Also don't tell them that they're all going to grow up to be a rogue herd.) Actually, this is worth a paragraph or so of thought, not so much because Corrigan is out of his mind but because he's not. The difference between Corrigan and Greenspan on this issue is not the sense of futility in the face of uncontrollably emotional (Greenspan) or herdlike (Corrigan) market behavior -- you, me, Jerome Kerviel -- but in their response to this reality: Greenspan says sit back and take it, Corrigan believes in reform and risk management. But how does this deeply pessimistic world view jive with what's clearly been the ascendancy over the last three decades or so of the market as not only the most efficient allocator of capital, but as the best "predictor" of the future and, generally, a font of liquidity, wisdom, even omniscience? True, there have been, particularly of late, academic critics like Joseph Stiglitz and members of the behavioral school, who have emphasized market failures; that camp clearly has a future. But in corporate life, on Wall Street, in personal finance, the notions of an efficient and rational market still shape behavior, from compensation to strategic hurdles to the triumph of mark-to-market accounting.
The difficulty of holding those two thoughts together -- irrational market versus efficient market -- suggests just why this current crisis feels so fundamental. The issue these august regulators inadvertently summon up is what is the inner nature of the market, and should we make this amazing mechanism so central in our lives? Does it have to be so large, so global, so deeply intertwined with aspects of life, like culture, education or family life, that have traditionally operated separately with different values? Can we retain the material wonders that these markets can generate -- and they can't be dismissed unless you want to live in a cave -- at the same time restraining its, in Levitt's terminology (harkening back to John Maynard Keynes who knew a thing or two about market behavior), animal spirits?
Our former regulators do not offer uplift and cheer -- maybe that's their jobs. Corrigan is particularly chilling, not only because he's been at this a long time, but also because he's not ideological, like Greenspan, or political, like Levitt. But it's a little hard to imagine moving forward with, say, a powerful "market stabilizer," if the markets are so powerful and regulators, as mere men, are so relatively limited. Conversely, how many of those ultimate market mavens on Wall Street want to venture out into the markets today without the protection of regulators? - Robert Teitelman
