A Federal Department to Regulate Financial Journalists

Posted: Apr 05, 2012 12:01 AM

The normally insightful Gretchen Morgenson ran a column Saturday that I at first suspected must have been intended for April Fools’ Day.  She discusses a paper by University of Chicago professors Eric Posner and E. Glen Weyl that suggests we create an agency like the Food and Drug Administration for financial products.

I haven’t yet read the paper, but given some of the remarks, I am not sure its worth the effort.  

For instance, Weyl states, ”[w]e tried an experiment with a very radical form of deregulation that has very little basis in sound economic science.”  In what universe does one live in to believe our financial system had a “very radical form of deregulation”. 

Our financial markets are, and have been for a long time, massively regulated.  That’s the problem.  The moral hazard and perverse incentives created by our existing system of financial regulation should be clear to anyone with a basic understanding of “sound economic science”.

Take the example of credit default swaps (CDS). The good professors posit “[i]magining a credit default swap being brought before a financial protection agency,” Mr. Posner and Mr. Weyl wrote: “We would expect the F.P.A. to treat it skeptically.” Really?  CDS were brought before the NY Fed, who signed off on them as a great way for banks to manage their risk (and hence reduce their capital).

We had a massive financial crisis because households, banks, bureaucrats and politicians rationally responded to the perverse incentives they faced.  What’s crazy about defaulting on a mortgage when you’ve put nothing down and there’s no recourse.  (Let’s not forget it was some politician that decided that recourse was a bad thing). 

If you want a better system, fix the incentives. 

Thinking that the same failed regulators who missed, and contributed to, the last crisis are going to fix the next one strikes me as naive, as well as having “very little basis in sound economic science”.