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Sunday, April 24, 2011

"Reject Greenspan’s Bleak Vision"

Jon Faust of Johns Hopkins Center for Financial Economics:

Reject Greenspan’s Bleak Vision, by Jon Faust: Alan Greenspan recently argued in the FT that the Dodd Frank Act fails to meet the test of our times. In defense of this view, Greenspan paints a disturbing view of the modern world as a financial dystopia in which humans are at the mercy of a financial machine they have built but can no longer hope to manage. Greenspan argues,

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 of modern financial systems. ... With notably rare exceptions (2008, for example), the global “invisible hand” has created relatively stable exchange rates, interest rates, prices, and wage rates.

... Greenspan’s bleak vision, like Orwell’s before him, may prove correct. My view is that the financial crisis was not a sad by-product of modernity but rather a new episode in a very old story: systems that allow risk taking and innovation are inherently subject to periodic crises. We can surely avoid another crisis by outlawing all risk taking. The alternative is to strive provide a stable backdrop in which productive risk taking can flourish. The history of progress financial progress has, arguably, been one of generally increasing stability -- in economies where development has been allowed to occur -- supported by an evolving system of market and political institutions, laws and regulations.

Greenspan is right that the Dodd Frank Act, like every hasty response to upheaval, is grossly imperfect. The Patriot Act comes to mind. The Federal Reserve Act of 1913 was itself a crisis response and was substantially modified over more than 20 years before reaching the form we recognize today.

We should continue the job of reform and not surrender to Greenspan’s dystopian vision.

Greenspan is yesterday's news, and the substance of what he says won't have much impact on policy. But what he is arguing is notable because it represents a common point of view that Dodd-Frank will do little except reduce economic growth and, to the extent possible, it should be reversed.

And the financial industry is taking advantage of this. While our attention is diverted to other matters, e.g. protecting social insurance from the latest onslaught from the right, the financial industry is quietly -- and in many cases successfully -- pushing to ease the restrictions in Dodd-Frank (you can track changes to Dodd-Frank here). Too many people still believe that anything that's good for the bottom line in the financial sector is good for America despite recent evidence to the contrary.

I don't think we'll ever be able to completely prevent crises, but we can reduce the damage that a crisis can do, and we can make crises rarer than they've been recently. However, that requires doing things that the financial industry does not like. With both parties dependent upon financial industry money to fund their reelection campaigns, and with so much of this under the public's radar, it's not at all clear that Congress will take the steps that need to be taken, or even hold the line on the regulations that are already in place.

    Posted by on Sunday, April 24, 2011 at 09:27 AM in Economics, Financial System, Regulation | Permalink  Comments (23)


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