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Greenspan's regulatory fatalism

by Robert Teitelman  |  Published March 30, 2011 at 1:07 PM
greenspan125X100.jpgThe buzzword of the day is distortion. In the Financial Times, Alan Greenspan returns to blast Dodd-Frank for creating "market distortions," and worse -- oh, much worse. Elsewhere in the paper, HSBC chairman Douglas Flint called for an expansion of the list of systemic banks in order to avoid "competitive distortions building up in the bank market." And in The New York Times, Neil Barofsky, the special inspector general of TARP, whose job ended today, offers as part of a litany of complaints about the program that "credit rating agencies incorporate future government bailouts into their assessments of the largest banks, exaggerating market distortions that provide them with an unfair advantage over smaller institutions, which continue to struggle." In a case of very strange bedfellows, Barofsky, like Greenspan, is also unhappy with Dodd-Frank. On the other hand, who listens to credit rating agencies anymore anyway? Maybe that's the distortion. All three of these folks are talking their own book. The most intriguing, psychologically and ideologically, is Greenspan's FT column. After all, Greenspan was the Great Confessor, who admitted to flaws in his belief in the ability of markets, and financial institutions, to discipline themselves. That's a pretty fundamental admission. He has been blamed not only for the deregulatory impulse that opened up floodgates of leverage and risk (sometimes fairly, as on derivatives, sometimes not), but for keeping interest rates low for so long after the dot-com bubble burst, and for a general failure at the Federal Reserve to pay any attention to what was building up in the mortgage markets. As a capper, Greenspan has long been the most articulate champion of the belief that regulators are helpless in the face of an inflating bubble; and that they can really do little to combat it short of cleaning up the mess afterward. This is controversial and much debated. And while it embodies a kind of deterministic, or fatalistic, school of market regulation, there is enough truth in it to make one fear for the future. Indeed, if Greenspan is right about that, then the solution is not passivity but radical structural change. If you're worried about dying from Russian roulette, then the only real solution is to take the bullet from the chamber or toss the gun away. Change the game.
 
But Greenspan, in this persuasive exercise, argues that not only is a more activist brand of regulation useless, and market distorting, but that we can't change the game. On the former point, Greenspan ticks off a list of "regulatory inconsistencies [stemming from Dodd-Frank] whose consequences cannot be readily anticipated." This list reads like talking points of a bank lobbyist in a threatening mood: Securitization is screwed, banks will yank debit cards, foreign exchange derivatives will flee, proprietary trading will settle in friendlier climes and -- oh my God! -- attempts to rein in compensation will fail. (Of course, regulatory arbitrage is a two-way street: In his talk, HSBC's Flint, sounding Greenspanian, openly discusses leaving the U.K. if the Brits separate investment from retail banking. And The Wall Street Journal's Heard on the Street today suggests that Barclays is mulling moving its investment bank to New York.) "The act," he declares, "may create the largest regulatory-induced market distortion since America's ill-fated imposition of wage-and-price controls in 1971." This is the subtle Greenspan. He's linking Barack Obama to Richard Nixon and tying, ever so sneakily, Dodd-Frank to the chronic inflation that followed wage-and-price controls. Maybe it's a little joke for Paul Volcker, just among us central bankers.
 
Greenspan pursues his own logic with a short meditation on a big problem: Finance has become too globalized, too interconnected, too opaque. And the even bigger problem is that regulators can't predict the future! (And, he implies, neither should they try -- distortions, you know.) That includes Greenspan himself, of course; and thus, in another rhetorically skillful move, he damns Dodd-Frank while taking himself off the hook. Alas, in doing so he presents a globalized finance that's a nightmare. "The problem is that regulators, and for that matter everyone else, can never get more than a glimpse at the internal workings of the simplest financial system. ... In the most regulated financial market, the overwhelming set of interactions is never visible. This is the reason that interpretation of contemporaneous financial market behavior is subject to so wide a variety of 'explanation,' especially in contrast to the physical sciences, where cause and effect is much more soundly grounded."
 
But do not fear. We can't do a damn thing about it, so kick back and guzzle the punch. Greenspan offers up a two-part analysis of why regulatory passivity is the only way. First, and this is a return to a theme Greenspan once pursued with considerable avidity, the good outweighs the bad. This raises his argument to comic heights, as if he were frantically pressing all the old buttons. "Today's competitive markets, whether we seek to recognize it or not, are driven by an international version of Adam Smith's 'invisible hand' that is irremediably opaque. With notably rare exceptions (2008, for example), the global 'invisible hand' has created relatively stable exchange rates, interest rates, prices and wage rates."
 
Oh, that silly 2008, which was also 2009 and 2010 and still seems active in 2011, what with unemployment a tad high and housing prices falling again. And that "irremediably opaque" has to be enthroned with "irrational exuberance" in the Greenspan bot mot hall of fame. "Irremediably opaque" suggests regulators have no role; that against the possibility of market breakdown, we, as a society, are helpless. Ayn Rand and the "invisible hand" are back and living in Greenspan's brain.
 
But he is not done yet. How did we get here? Why are we enslaved by these beneficent markets? Why can't we act to change this system to something akin to that of a half century ago? Greenspan tries out some answers, despite the fact that he's already admitted the future is blank as far as he's concerned. "That may not be possible if we wish to maintain today's levels of productivity and standards of living," he writes. Financial complexity, he posits, has grown with "the rising division of labor, globalization and the level of technology." That explains -- and justifies -- the explosion in finance as a proportion of the economy. The fact that he doesn't really answer the question doesn't seem to matter. The question is not that complexity follows technology or this "division of labor," but whether it's inevitable, or whether financial prosperity and growth can't be achieved in other ways. This is worse than regulatory fatalism; it's historical fatalism. It is what it is. And what was will ever be. I got mine, Jack.
 
But then, just as he's wrapping up, Greenspan hesitates against the specter of this bleak determinism. "The vexing question confronting regulators is whether this rising share of finance has been a necessary condition of growth in the past half century, or coincidence." Yes, Big Al, that is the question, and it is vexing. But in admitting that pale shaft of doubt into the darkness, Greenspan threatens the entire structure that he has carefully reassembled after the storm. Maybe financial complexity is not necessarily related to living standards. Maybe there is a better way. Maybe there is a role for regulation. Maybe there is a tradeoff here somewhere.
 
Or maybe we should take the bullet from the chamber. - Robert Teitelman

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Tags: Alan Greenspan | Dodd-Frank | Neil Barofsky | Paul Volcker | TARP | Troubled Asset Relief Program
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