Financial Reform

Financial Reform:

I suppose this is the business of the day. Financial reform is not among my chief interests, but a citizen ought to try to develop a basic understanding of critical matters even where he is not interested in them. We do have to advise our representatives, and keep watch on them as well as we can.

So, here are two interesting pieces, and one comment:

This piece by an IMF 'old hand' was very interesting, and I think you should all consider it. We might discuss it here, to see how plausible his analysis is. If he's right, something like a 'bank tax' is nonsense; the banks are quite undercapitalized as it is. He recommends nationalization, bank breakup, and a turnover of our 'elites' in this society so that the US government is no longer captured by the financial industry. Radical stuff; but he says that other nations that have taken such radical measures have enjoyed rapid turnarounds. The US is unlikely to do so, because our financiers don't want to be turned out, and they control the government; plus, unlike many third world nations, we pay our debts in our own currency and can therefore simply print more of it. That way lies disaster, he says.

Another piece suggests that 'global rules' for capital might be in order. This is in keeping with the IMF hand's general concept that an internal US political solution would need to be more radical than Washington is likely to support. The bankers themselves were consulted, and here is where I would like to comment:

One participant at a US Federal Reserve meeting this month to discuss the new regime said “full and frank” did not do justice to the furious response from some industry delegates.

The reaction from capital hawks was that a blunt backstop might be better than an overreliance on the sophistication of risk models and regulators. They also said banks would be given plenty of time to adjust to the new system, perhaps several years, to minimise the immediate impact on credit provision.

Now that is very plausible, given Nassim Nicholas Taleb's Fourth Quadrant argument, which I find highly persuasive. Risk modeling in these cases is doomed to failure, if the 4Q argument is correct: thus, any reliance on 'sophistication of risk models' is overreliance.

Sometimes blunt instruments are the right tool for the job; there are things one can do with a sledgehammer that cannot be done with a scapel. If you insist on using only the scapel, you will eventually fail at the task.