Monday, October 20, 2008

The financial crisis and libertarianism.

Jacob Weisberg has a new Slate article titled The End of Libertarianism: The financial collapse proves that its ideology makes no sense.

It's not a perfect article, and it may claim a bit more than is justified, but the basic point is sound. Financial markets cannot regulate themselves in ways necessary to prevent disasters, contrary to libertarian propaganda.

The largest cause of the financial contagion has been the credit default swap. These are unregulated, high-leverage derivatives that were created to circumvent normal insurance regulations. Without these derivatives, the damage done by the housing bubble collapse would not have paralyzed the entire lending industry.

Libertarians love to claim that markets swirl around and circumvent attempts at government control. Now we see the result of letting them do it. Numerous people called for this to be regulated, but the market fundamentalists were too influential.


Glen said...

Weisberg claims a lot more than is justified. "Regulation" is not some magic whiffle dust you can spread over a problem and make it all better. Sometimes regulations make things better and sometimes they makes it worse; this situation had quite a lot of both. For all he knows, sprinkling more "regulation" on the parts of the system he doesn't like could have made the problems worse rather than better. So: what exactly would he have done differently when? Who, exactly, proposed something specific that would have improved the world, how was that specific proposal thwarted specifically by libertarians (as opposed to random partisan bickering, special interests, and status-quo-favoring bureaucrats), and what evidence do we have that the alternative would have been a net positive?

Regulations are almost always backward-facing - we pass laws to prevent the last big problem, while in doing so laying some of the seeds for the next one.

Weisberg's implied faith that all Big Problems of the world could have been prevented if only we'd have put the right Bureaucrat-Gods in charge is touching, but silly.

Glen said...

BTW, one example of old regulations causing problems in new contexts is "mark-to-market". In response to Enron we passed new rules that made it harder for banks to fudge the numbers and look solvent when they might not be. The post-Enron combination of stricter accounting rules and stricter reserve requirements probably made some institutions fail this time around that didn't need to and wouldn't have had to under the prior, more flexible, regime.

(Which doesn't mean the new rules shouldn't have been passed. Sometimes bad outcomes are unavoidable. Rules that cause specific failures might still be beneficial on balance, weighing the bad against the good. But you need to do that sort of accounting. You need to think about the potential downside, as well as the potential upside, of new regulations. Weisberg doesn't seem to be doing that.)

Mike Huben said...

You know, if I wasn't familiar with Glen, and I read that, I might think "Wow, Glen is so wise and cautious."

But Glen and I have been arguing for a long time, and I recognize this as his "I doubt it" tactic. It doesn't matter what government action he dislikes: point out that knowledge isn't perfect, sometimes there are unexpected problems, etc. You could use this tactic on ANY position: it's a basic technique of DENIALISM.

Not only that, but it's a technique for the ignorant to target the ignorant. Because if you know anything about history of regulation in this field, you know that banking regulation has had some terrific successes since the great depression, and no failures approaching the size of the great depression nor causing a great depression.

As for Glen's criticisms of Weisberg, they're silly. Weisberg in no way implies libertarians thwarted regulation (they're insignificant): he points out that libertarian claims that markets will effectively self-regulate to prevent problems have been shown to be dead wrong. Glen then goes on to demand explanations: how much should Weisberg have put in his article, Glen? A thousand pages to refute every cockamamie point you could bring up?

The simple fact is that limits to leverage which have prevented banking and investment crises since the 30's were circumvented by the creation of unregulated credit default swaps. Many economists and investors pointed out this hazard, but free-marketeers (like Alan Greenspan, according to Paul Krugman) sneered and blocked regulatory action. We have every reason to expect that what worked to prevent such catastrophes for 70+ years would have worked for this also.

Glen said...

"It's more complicated than that" is a perfectly appropriate response to people who use ambiguity as an excuse to bash their favorite demons rather than a prompt to investigate what's actually going on.

"libertarian claims that markets will effectively self-regulate to prevent problems" is a strawman; neither self-regulation nor government regulation is guaranteed to prevent problems. Any time anything goes wrong in the world, somebody like Weisberg can claim that the correct sort of "prudent regulation" would have prevented it. You could use this tactic on ANY position: it's a basic technique of UTOPIANISM.

But hey: utopia isn't an option. We live in a world of imperfect actors and imperfect institutions, including governmental institutions.

Libertarians acknowledge the imperfection of both markets and regulatory institutions and apply skepticism towards claims as to the likely effectiveness of the imaginary regulatory regime we might have had in some alternate universe. Including alternate universes in which libertarians had less influence.

Near as I can tell, there isn't yet much of a consensus as to exactly what caused the recent meltdown to be as bad as it was. There were areas where too little regulation seems like a contributor, there are areas where too much regulation or the wrong regulations or incompetent regulators seem like a contributor, and still other areas in which nobody really foresaw the problems clearly enough to think they might have been averted under any likely regime. Yeah, it's a big mess, and since we're coming up on an election both sides have reason to demagogue over it. But it's way too soon to think we understand this well enough to correctly apportion blame.

(FWIW, I'm standing on firmer ground here than usual because I work at a New York hedge fund.)

(And if you're still inclined to a knee-jerk liberal response, first consider what I haven't said above. I haven't said government caused this or made it worse. I haven't said it would have all been wonderful without any regulation, or merely better with less regulation. If I were being a knee-jerk libertarian on this issue I might have made claims like those. And I would have been wrong to do so. Just as wrong as Weisberg.)

Jeremy said...

Are Fannie Mae and Freddie Mac market entities? Do we have a free market with no barriers to entry for competition in banking? In currency? Is corporate entity status something that magically manifests, or is it created by government?

I don't have any problem with critiques of the free market, so long as they're actually critiquing a free market. But we haven't seen such a thing.

That said, there are a lot of really rich and powerful people who benefit from pretending that this is a free market. Except, of course, when they need a handout.

Anonymous said...

"Deregulation" only makes sense as a bargaining position for busines lobbyists trying to remove regulations they don't like (including some that genuinely should be removed). It's only the libertopians who swallow this whole and conclude that any and all regulation is inherently bad. The same goes with their position on taxes.
Now that the shit has hit the fan, however, most people (and economists) in the industrialised world seem to have no problem at all with the regulations, keynesian stimulus measures, etc, that will be needed to keep the market running properly. When real money and real livelihoods are at stake, the first frivolous luxuries to go are libertarianism and ayn rand.

Mike Huben said...


"It's more complicated than that" is a general purpose denunciation that can be applied to any argument. If I say a dropped ball will hit the ground, you're more complicated argument may take into account whether it is lighter than air, whether there is a crosswind, whether it's over the ocean. The question is whether the complications are correct and significant to the argument. And when I do indeed drop the ball and it hits the ground, we see that your objections WERE incorrect and insignificant. And this is a pattern that I see in your arguments over and over for years.

You say my statement "libertarian claims that markets will effectively self-regulate to prevent problems" is a strawman. It is not a strawman: this is a very frequent claim in the libertarian literature. I have not misrepresented a libertarian position here.

Any time anything goes wrong in the world, somebody like Weisberg can claim that the correct sort of "prudent regulation" would have prevented it. Weisberg actually wrote: "Had the advocates of prudent regulation been more effective, there's an excellent chance that the subprime debacle would not have turned into a runaway financial inferno." First, Weisberg is much more tentative. Second, it is not mere speculation, but historical fact that the regulation was suggested in advance and politically defeated by special interests. And third, in hindsight many economists and businessmen agree that the regulations likely would have worked. So this is not simply an automatically generated, unsubstantiated claim as you would have it, EVEN IF IT COULD HAVE BEEN. Thus, not mere utopianism as you accuse.

Unknown said...

Anthony Gregory's libertarian response to the article in casr you are interested:

Mr. McCoy said...

Just Say No!

I never imaged myself saying this, but I miss Nancy Reagan. We all laughed when she told teens to "Just say no." But that is exactly what we need to tell Congress. Just say no to bailing out the Big Three auto makers. Here's why:

First, while the Big Three are in a crises, all the other auto companies manufacturing cars in this country (Honda, Toyota, Nissan, Kia, Hyundai, BMW) are not. Those companies listed have all diversified into passenger cars that consumers what. The Big Three have become dinosaurs in responding to consumer demands and should be left to die.

Second, instead of permitting a bailout, the Big Three should be required to file for Chapter 11 bankruptcy, where a judge will require meaningful restructuring and renegotiations.

Third, the claim that the Big Three will repay the 25 Billion dollars is a pipe dream that no one with any common sense believes.

Finally, any bailout would be unfair to taxpayers because it would allow legalized theft by the government of our property (i.e. our hard-earned money.)

Yes, I miss Nancy Regain. But we can keep her words and message alive by writing our legislator in Washington.

Mike Huben said...

I'm not surprised that McCoy misses Nancy Reagan: her reliance on astrology was as stupid as his reliance on libertarian ideology.

Perhaps McCoy doesn't remember that 30 years ago, the Chrysler Corporation needed a bailout. Free marketeers of that era made the same denunciations, predicted that no amount of bailout would help, and claimed we were just throwing away tax money.

But the bailout worked: we've had 30 years more productivity and competitiveness from Chrysler, the loans were all paid back, and it didn't cost the taxpayers a dime.

Forcing the big 3 into bankruptcy favors high unemployment and oligopoly. We shouldn't want to increase those in the middle of a recession.

Glen said...

Letting Chrysler go bankrupt probably would have "worked" quite similarly as did bailing them out. That is, it would have led to mass layoffs and the creditors taking a bath, which is essentially what happened anyway. Do you disagree with this summary of the situation?

(As for your earlier response, it seems like we're down to quibbling over definitions. Market-based regulation does prevent some problems, as does government-based regulation. Neither one prevents all problems. I read Weisberg (and by extension, you) as saying "some economists think some regulations we could conceivably have passed might have prevented this issue, therefore libertarians are idiots for opposing regulation." It's clear he and those he argue with are talking past each other; he doesn't notice the gap between regulations that seem theoretically possible and those that are politically likely, nor does he give any weight to the opposing consideration that some economists think some regulations we were likely to have passed if the matter came up for consideration might have made things worse. It's that last part that makes him seem utopian to me - only a utopian would automatically assume more regulation = better results. Or would try to win a political argument by simply wishing away those who have reason to hold contrary views. Gee, if only those mean people who believe differently from me would disappear, then I'd get my way and everything would be wonderful! Is that not the essence of his argument? If your ideas don't prevail in a democratic system, maybe you should make better arguments for them! Or maybe your ideas shouldn't prevail, or maybe your ideas are failing due to a public goods failure of much the same sort that leads libertarian economists to favor leaving tasks to the market whenever possible. Whatever the case, banishing your opponents from respectability is not in the available opportunity set for addressing the issue at hand.)

Mike Huben said...

The Heritage Foundation article is a pathetic piece of one-sided spin. I'm not surprised that you can't find it's errors, Glen.

"only a utopian would automatically assume more regulation = better results"

As opposed to a libertarian idiot who automatically assumes less regulation = better results?

Weisberg was addressing specific regulations for specific conditions that have been tried and succeeded in other financial disasters: not the wild-assed random regulation that your imaginary strawman opponents enact.

Your pretense that you are wise and consider both sides (but nobody else does) makes you look foolish. Especially because if you are claiming to judge the balance, you need to have believable numbers for both sides, and you don't.

Glen said...

Weisberg was addressing specific regulations for specific conditions that have been tried and succeeded in other financial disasters.

You appear to have read a different article than I did. In the one I read, Weisberg mainly advocates that sometime between 1998 and today somebody in authority should have asked for "some additional rules here" and also wishes that the advocates of prudent regulation [had] been more effective.

Heck, even I wish the advocates of "prudent regulation" had been more effective! The only disagreement there would be over which rules constitute "prudence" and how to measure the effectiveness of these prudent rules.

Weisberg appears to define effective regulatory action as whatever would have happened if people like Gramm and Cox hadn't gotten in the way. And he does give a few examples, but doesn't come anywhere near making a case that his specific favored set of regulations would have been substantially better than somebody else's.

And for the record, I still haven't blamed the problem on regulation. Weisberg is in my view correct when he says "the libertarian apologetics fall wildly short of providing any convincing explanation for what went wrong." However, they aren't alone in that regard. Nobody yet has a convincing explanation of what went wrong!

Here are a few blog postings I found useful last month:

MM on m2m and instability
MM on bank policy
MR on what caused the crisis

They're long, but worthwhile. A few high points I gleaned from those and other sources were:
(1) the crash was complex and probably had too many components to say that any one single factor "caused" it.
(2) Many people - including Weisberg - have proposed plausible-sounding "causes" that fail to hold up when you take the foreign experience (what happened in the UK, in Germany, in Iceland...) into consideration.
(3) It is far too simple to suggest we just needed "more regulation" (as do some on the left). Or, for that matter, "less regulation" (as do some on the right). In some cases, the "more regulation" we added to address prior crises seem to have made things less stable this time around.
(4) post-Enron "mark-to-market" rules combined with mandated rating agencies and reserve requirements can be destabilizing when the market breaks down, but...
(5) the fact that some regulatory framework caused problems (or merely failed to prevent them) doesn't mean it wasn't the best framework available given the information we had at the time. Or in other words:
(6) Sh*t happens. Or to put that in libertarian terms: "Utopia is not an option."

Mike Huben said...

Apparently I did read another article: the one Weisberg linked to that identified Born as asking for regulation. You should try following links some time when you want to make stupid claims.

And before you can quibble about which rules would have been effective and prudent, it is necessary to attempt some rules. But judging from your general style of argument, you're not even able to adequately judge historical evidence because your arguments are innumerate.

Glen said...

Yes, Born was "asking for regulation". In 1998, before he quit the job in 1999. Regarding a variety of derivatives which the WaPo article admits "...did not trigger what has erupted into the biggest economic crisis since the Great Depression." Rather, their proliferation merely "magnified the panic." In short, Weisberg is doing what he accuses "libertarian apologists" of doing: focusing on one or more contributing factors but falling short of fully "providing a convincing explanation for what went wrong."

We did "attempt some rules". A great many rules. Some were even enacted. Of those, some helped, some hurt, most had unknown net effect. The notion that having adopted different rules in 1998 would have caused an on-net better outcome this year is probably unfalsifiable and hence unprovable, but one might make plausibility arguments in both directions. Weisberg doesn't seem compelled to do so; he regards the case as self-evident. He apparently thinks crashes have causes and can be prevented and therefore if there was a crash and we can find somebody in the past who was prevented from doing something he thought might reduce the likelihood of a crash in the future, well, that guy could have stopped it.

Me, I'm not yet convinced that crashes can be prevented. Which makes me less utopian than he is.

On a related note: why do you think banks got into more trouble than did hedge funds this time given that banks are much more heavily regulated, more subject to reserve requirements, more transparent in their operations, and generally less exposed to the latest newfangled derivatives?

Also: why do you think various european countries got into financial trouble with emerging-market investments at roughly the same time the US got into financial trouble with mortgages and CDSes and such? Is that also Phil Gramm's fault? If Born had had his way, would Iceland be solvent now?

I have my own theories but I'd love to hear yours, since I'm apparently just a libertarian idiot who makes stupid claims.

Glen said...

I keep forgetting to take into account that you are determined to resolve every ambiguity in the direction of believing the person you are arguing with is an idiot. Much as Skeptico's crowd was with Palin. So just to clarify before you jump on it: What I am not yet convinced of is that crashes can be *entirely* prevented.

(Not by regulation, not by market competition, not even by praying to the Flying Spaghetti Monster.)

(This is actually a restatement of an earlier ambiguously-stated claim which on reflection should have been worded: neither self-regulation nor government regulation is guaranteed to prevent *all* problems.)