Regular readers may recall that I have occasionally declared the Claremont Review of Books (subscribe here) to be my favorite magazine. The Fall issue is in the mail and the Claremont folks have once again let me select two pieces from the new issue to preview. First up is James Keller’s “Is Deregulation to Blame?” In the review Keller evaluates two new books on cause of the financial crisis.
Taking issue with Judge Richard Posner’s A Failure of Capitalism, Keller asserts that the financial crisis wasn’t caused by financial deregulation. The solution to the crisis is therefore not more regulation. The Obama administration has of course taken the position that massive additional regulation is necessary.
In taking issue with Judge Posner, Keller draws on his own experience as the former head of structured products at UBS. Keller agrees with Judge Posner that financial services are the subject of a welter of regulators. Keller faults Judge Posner, however, for failing to catch “the high correlation between the level of regulatory scrutiny and the contribution to the credit crises.”
Keller argues that “[t]he rush to re-regulate ignores the reality that the least-regulated entities in the system–hedge funds–fared far better than the highly regulated entities like banks and insurance companies.” When regulators are at sea, the conclusion can’t be more regulation. Those who call for more regulation “seem to envision a superhuman regulator who will catch excesses before they occur.” Keller argues that if creditors are forced to be vigilant for the possibility of real loss, we won’t need to expect heroism from our regulators. Keller observes that Judge Posner offers little in the way of evidence to support his argument:
Posner is so sure that deregulation caused the crisis, he hardly bothers to offer any evidence that it did. It didn’t. There are really no linkages between specific deregulatory actions and the current crisis. Unfortunately, his admonition to go slowly in crafting new regulations is likely to be ignored, and the failed regulators are busy drafting new rules to cover past incompetence. To the extent Posner provides ammunition for the re-regulators, he does us all a disservice.
By contrast with his view of Judge Posner’s analysis, Keller credits Stanford’s John Taylor with a proper understanding of the financial crisis in Taylor’s Getting Off Track. Referring to former Treasury Secretary Paulson’s decision to let Lehman fail last year, Keller writes:
Taylor correctly argues that, after Lehman’s collapse, the threat to the system was uncertainty. Who would be next? At that point there was a need for regulators to identify which financial institutions were healthy, and which were not. Regulators missed this opportunity, markets unraveled, and beginning with AIG those deemed too big to fail got bailed out.
In retrospect, it appears that the regulators failed to separate the strong from the weak because they simply did not know which was which. The fact that [Treasury Secretary Timothy] Geithner was initiating stress tests on the nation’s 19 largest banks in the first quarter of 2009 surely points to massive regulatory incompetence. What in the world had he been busying himself with beforehand? Apparently, before April 2009 regulators did not know which financial institutions could weather a 25% downturn in home prices and an unemployment rate above 10%. These same folks now want more authority.
In light of the legislation making its way through Congress, Keller’s review could not be more timely.