There is little evidence that deregulation or banks’ compensation practices caused the financial crisis. What did seem to cause it were capital regulations imposed on banks across the world. These regulations explain why bankers who are commonly seen as having recklessly bought risky mortgage-backed bonds in order to boost earnings—and bonuses—actually bought the least-risky, least-lucrative bonds available: those that were guaranteed by Fannie Mae or Freddie Mac or were rated AAA. These securities were decisively favored by capital regulations, raising the question of whether regulation actually increases systemic risk. By definition, regulations aim to homogenize the otherwise heterogeneous behavior of competing enterprises. Since one set of regulations has the force of law, it homogenizes the entire economy in that jurisdiction. But regulators are fallible, and if their ideas turn out to be wrong—as they appear to have been in the case of capital regulations—the entire system is put at risk.
Monday, 15 February 2010
A more realistic view of capitalism
In a paper at the AEI, Jeffrey Friedman and Wladimir Kraus argue that there is A Silver Lining to the Financial Crisis: A More Realistic View of Capitalism. The abstract reads: