Judge Richard Posner spoke at a Federalist Society event on campus back in the fall of 2009 about why it’s a bad idea to react too quickly to regulate the financial sector. The HL Record coverage of the event is here. Here is a (slightly long-winded) disagreement I wrote back in December.
During the introduction, the Fed. Soc. President called Judge Posner the only intellectual whose name comes up in every law school class, and I have to agree this has held true for me as well. However, since the economic crisis in 2008, it’s hard to deny how intensely political his positions are and just how much law this man has made up.
Posner was arguing against the Treasury Department’s proposed regulations, but the talk turned into a critique of financial regulation in general. My outline doesn’t precisely match the outline he was following, but I did number several of his major arguments against financial regulation, and my disagreements follow.
1. Regulation will decrease confidence and predictability in the markets.
Posner made the Keynesian point that during an economic crisis, a lot of the problems are purely psychological. Companies hoard money out a fear that if they invest it, the investments will just decline in value because consumers aren’t spending. People become more afraid to invest and save more, and that eventually leads to further layoffs and slowdowns. If nobody starts spending money, this problem spirals. You need to create confidence to get money flowing again. That’s the standard Keynesian argument (which Bush famously grasped) — you need people to spend.
Posner’s next step from there is to say new regulations add uncertainty to the market and discourage investment and spending — right now we want money flowing, and any regulation would only restrict that flow. This is an empirical question which Posner gave no evidence to support. Saying regulation creates uncertainty is just begging the question.
His position is only true if we choose regulations that create uncertainty or instability. You could just as easily claim the opposite — we will choose regulations that make the markets more predictable (by increasing transparency, making sure that liabilities are on the books and not in SPVs, setting capital requirements, etc.). Not regulating leaves also the looming specter of regulation in the air. During the Great Depression, the government saw regulation as the precise way to recreate consumer and investor confidence, which is what led to the 1933 Glass-Steagall Banking Act and the creation of the FDIC.
Posner acknowledges that financial organizations are sitting on nearly a trillion dollars beyond their capital requirements, yet they are not yet confident enough to reinvest. Consumers are saving more because they don’t feel secure in their employment. The claim that regulation would diminish confidence in the market is an unfounded, primarily political statement. Regulation has provided a confidence boost in the past, and it’s not clear that it couldn’t do it again.
2. We don’t have a good account of the crisis yet, so any proposed regulations would be premature.
I agree that we need to come up with a clearer version of what went wrong before we start tinkering too much with the market. But rather than concluding we should do nothing, this point could also justify a modest approach to regulation. For instance, it’s widely agreed that teaser-rate mortgages are problematic, that credit rating agencies face impermissible conflicts of interests, that certain leverage ratios are unacceptably high, etc. Regulation can be narrowly tailored.
Secondly, the government has already injected itself into this situation. Further action is not premature. The notion that we should not regulate, but that we are willing to make taxpayers responsible for an undefined, astronomical line of credit is misconceived given the current extent of government involvement.
Markets are typically characterized by the idea that companies who can’t pay their debts are driven out of the market place. We have currently created a situation where defaulting on one’s loans is no longer grounds for bankruptcy — even if this was the correct or necessary decision, it’s pure semantics to say that government involvement of this magnitude is not ‘regulation’.
Posner is right that there is a problem with our current efforts at reaching an authoritative account of the crisis. The Financial Crisis Inquiry Commission (FCIQ) is a 10-person commission charged with investigating the lead up to the current debacle. Posner pointed out that it’s understaffed, politically not very important, and that it doesn’t have any economists on it (this last point at least is untrue). But he’s right in that understanding what happened in the financial markets should be one of the highest priorities in the country right now, comparable to the responsibilities charged to the 9/11 Commission.
3. The people in charge (esp. Greenspan) are responsible for the crisis and the way it unfolded.
Disapproving of some of the people in charge is unrelated to the question of whether or not regulation is needed. Additionally, naming a few individuals as scapegoats does nothing to create confidence that future crises of this sort will be averted. Even if certain individuals do bear a disproportionate share of the responsibility, this points to an underlying structural problem. One justification for regulating would be to prevent individuals from being able to exercise this kind of catastrophic influence in the future.
Posner believes the crisis was that it was primarily fueled by Greenspan’s decision to push interest rates to near zero and leave them there for years. This cheap credit powered the consumer and housing bubbles. In addition, he believes that treasury secretary and the head of the Fed. were largely responsible for the crisis because they allowed Lehman Brothers to go under. The point being, that if the government had prevented Lehman from collapsing by extending a low or guaranteeing a sale, that other financial companies would not have tried to increase their capital reserves and credit markets would not have frozen up.
Even if this account is true, and a handful of people at the treasury were in a position to prevent the credit freeze in the fall of 2008. This should not mean that the only governmental agencies capable of offering regulations ought to be disqualified from doing anything. If anything, it should compel us toward greater transparency and toward figuring out what powers these entities should in fact be able to exercise.
4. Financial markets are international, and regulation will have to be international.
This is something I agree with entirely, and I think it’s the most persuasive point that Posner made. If we regulate financial markets here in the US, and even if Western Europe regulates too, any other country on earth could choose to have more liberal economic regulations. And given the global nature of financial markets, nothing would stop money and financial talent from shifting to whatever country has the loosest restrictions.
His concern is that the US is only going to be hurting itself by losing financial talent by regulating preemptively, and that if we do too much, we will bind our hands in a way that will only hurt us. Financial markets are already completely international, and I agree that broad cooperation would be the most desirable solution.
However, a lot of American citizens/consumers have been hit hard by this crisis, and domestic regulation should not be off the table. We’d be waiting forever if complete global cooperation is necessary. It should be possible to write domestic legislation that addresses specific problems. And given the global nature of the crisis, there are good reasons to think other places will follow a U.S. lead in trying to restore lending and reduce the risk of future financial crises. A broken financial system hurts everyone.
Like I said at the outset, none of the reasons he gives for not regulating are very persuasive.
Photo credit: Siyuan Chen