To borrow Niall Ferguson's metaphor, if finance is an
evolutionary process, then regulation is its intelligent design which, I
would add, is a cognate of faith, not science.
Or, to take the observation of former Federal Reserve Governor
Frederic Mishkin, if "the financial system (is) the brain of the economy,"
then, I would suggest, heavy regulation is its lobotomy; while it removes
the emotional highs and lows, it also dulls the perception, facility and
adroitness. (Disclosure: In keeping with my long-held public view, I give
professional advice to financial institutions seeking low regulation and
A century ago, medical science had faith in lobotomies. Today,
it seems, Washington political science has faith in new financial
Medical science began to gain wisdom when it learned what
previously unrealized damage it caused when it lobotomized human brains. We
must hope that the "experts" today who are drafting new regulations by which
they would impair our financial system gain wisdom soon by recognizing how
little they understand the effects of these new regulations on our economy's
However, the current financial regulatory efforts in Washington
may not even deserve the honor of being compared to intelligent design or a
lobotomy. At least with those two processes, each has the intellectual
dignity of an internal logic even if that logic does not accurately
describe the reality it attempts to explain and manipulate.
Rather, the current likely financial regulatory efforts have an
almost random nature to them, as the legislative logrolling is collecting
unrelated and sometimes-inconsistent ideas that eventually will be called, I
assume, the Frank/Dodd Comprehensive and Rationalized National Financial
Redemption Act of 2009.
The final bill will be the compilation of the results of various
political battles being fought among the president, his various White House
economic and political advisers, the Treasury and various powerful committee
and subcommittee chairmen in the House versus their equivalents in the
Senate, as well as the successful interventions of various interests, the
institutional partial victories that are gained in the battles among the
half-dozen or so overlapping financial regulatory agencies in existence,
plus whatever the whimsical effects are of the backbenchers, the states, the
commentators, the media and, of course, the public.
Even if 10 of the smartest financial regulation experts in the
world got in a room and wrote an internally consistent set of regulations,
if history is any guide, it would not be likely to anticipate, avoid or
mitigate whatever the next financial crisis would be. As Ferguson wrote in
"The Ascent of Money," "It seems that, for all our ingenuity, we are doomed
to be 'fooled by randomness' and surprised by 'black swans.'" (See and
read two of Nassim Nicholas Taleb's intriguing books, "Fooled by
Randomness: The Hidden Role of Chance in Life and in the Markets" and "The
Black Swan: The Impact of the Highly Improbable.")
According to a study of financial data of the past two
centuries, there is a 3.6 percent per annum probability of a financial
disaster and, statistically, a 100 percent probability of a new financial
disaster within 33 years.
Treasury Secretary Timothy Geithner who is the lead
executive-branch figure designing new regulations to protect us from the
kind of systemic risk of failures by large institutions that we have just
experienced and are trying to work our way through inadvertently captured
perfectly the madness of the current Washington moment.
Geithner was quoted in last Wednesday's Financial Times: "I
think this has been a searing experience for financial institutions across
the world. The great risk we're going to live with for a very long time is
that risk aversion remains very high."
I happen to agree with him and made a similar observation in a
column last month. But I wonder when it will dawn on the secretary that he
is leading the team designing a regulatory system to protect us from
"greedy" and impetus-excessive financial risk takers destroying the world
economy, when, as he himself pointed out, the real next risk is probably
"risk-averse" bankers failing to make even sufficient prudent loans and
In other words, he is designing regulations that will force more
prudence and even slower and less circulation of needed money on a system
that he believes is already predisposed to be too prudent and too slow and
will circulate too little money to keep our economy humming.
Realists like to point out that most generals think they are
fighting the last war and thus lose the one they are in. So today,
Washington is busy preparing to protect our future economy which is
likely to be stagnant, risk-averse and weighted down with excessive debt,
high taxes, expensive energy and industrial policy crony capitalism
inefficiencies from yesterday's financial impetuosity and excessive risk
taking. Thereby, we will increase the stagnation, risk aversion and
middle-class poverty such habits will cause. Washington isn't writing a
financial regulation; it is weaving an economic shroud.