Why We Need More Financial Regulation
Did deregulation cause the Wall Street meltdown? Yves Smith discusses the dangers of deregulation and the unethical (if not illegal) behavior at Goldman Sachs.
Why We Need More Financial Regulation
Jill Schlesinger: With Financial reformed finally on the front burner in Congress
we’re pleased to have Yves Smith in the Money Watch Studio.
She’s the powerful voice behind the economic’s blog Naked
Capitalism and author of the new book “Econned”. Yves thanks so
much for being here.
Yves Smith: Thanks it’s a pleasure.
Jill Schlesinger: So you don’t like economist?
Yves Smith: I actually don’t dislike all economists. It’s this flavor of
economics. It is now called mainstream economics. It’s rooted in
the classical economics. There’s also with its evil sister financial
economics and at this were textbook teaching tools that would be
fine. It’s the fact that these very abstract models are taken away
beyond their limits both in policy and in practice. That’s where the
Jill Schlesinger: And how have those sorts of the new breed of economics? How
have those folks who spell that? How have they gained ground and
how they changed the system?
Yves Smith: Well the big way is the with the deregulation way that we saw on
the 19th and which we actually saw in the 70’s that Reagan was
given credit for but it started to before then. In theory, there’s
nothing wrong with finding the back right balance between
regulated markets and deregulated markets. This is political that
moves over time but with the endorsement of these different
schools of economics deregulation was pushed very hard
particularly in financial services where markets have a propensity
to be unstable and therefore it’s possible for as we’ve seen in the
crisis for self interested parties to basically get themselves in a lot
of trouble and brought customers into behaviors that in the long
term they are in their best interest.
Jill Schlesinger: So let’s look at that crisis for a second. So we have the economist
who come in and they say, “Oh, don’t worry based on our models
and based on everything we say markets are going to take care of
themselves so we don’t we need as much regulation.”
Now comes the crisis and what do we learn from that crisis? Do
we get to kind of throw the economist out and start over or what
are we to take? Is there anything good from what those economist
Yves Smith: There is. It’s just different schools. In fact, there’s one-school
information asymmetry but it’s not really well integrated into
policy or theory yet. But it basically says that if you’ve got parties
that know more than other parties you know that the guy who
knows less can be taken advantage. It was kind of common sense.
He knows a very famous people called the market for Lehman to
talk about the used car market.
As the prototypical example and the old regulations that we have
that the securities lost in 1933 and 1934 were very concerned about
disclosure. You know the old rules actually without having this
grand theory to wrap it in understood that there were issues if
you’ve got people who don’t have a level playing field in the terms
Jill Schlesinger: And do you think that that’s the core of the crisis even when we
just look at the mortgage crisis that people were getting products
they just didn’t understand. Do you sort of count in and then say
look if we had had more disclosure people really understood the
stuff they were buying we wouldn’t have gotten into this mess.
Yves Smith: That’s a very big part of it. I mean the part unfortunately is we’ve
got very bad incentives and this is another part of economics that
the model, that in financial economics the models all have the
effect of encouraging people to take more risk. So you sort of look
at each of the ways, the models have problems and yet you’ve got
investors particularly institutional investors who are measured on
one-year time frames so if one of their competitors is taking a lot
of risks and their performance is lagging even if they think it’s a
bad idea they’re going to lose out. The short terms and the other
guy will look better. They looked like an idiot.
And you know you’ve got these huge bandwagon pressures that
even if somebody really in his heart of hearts knows that he
shouldn’t be going along with that, he’s got a lot of institutional
pressure to follow the herd.
Jill Schlesinger: So let’s talk a little bit about that in light of this Goldman Sachs
and this Securities and Exchange Commission so we have this poor
slab named Fabrice Tourre, the fabulous fab who did seem to
acknowledge that things were beyond his capability of really
understanding who was getting beyond him. He puts this deal
together and at the heart of this matter it sounds a little bit like
asymmetrical information that Goldman had certain information
that they make. Maybe they should have told their clients or not.
But I want to ask a different question here, what about that conflict
of interests that exist right there in that moment. The Goldman
created a product that it’s sold one of its clients that it basically
knew was going to fail. Nothing illegal about that but what are the
ethics behind that? What are regular Americans supposed to take
Yves Smith: No it’s usually problematic and this gets very far away from the
idea of what market is supposed to do. I mean it would haven’t
occurred to somebody 20 or 30 years ago, the idea that a product
would be designed that was so much served one interest and
what’s the short interest. Normally people think of for example
capital racing. You bring a company public. People may differ
over the price and if the price is wrong it’s going to be a bad deal
but fundamentally you bring company’s public that presumably are
good companies. If you bring a company public that’s a sham
that’s usually huge calls for scandal.
Conceptually this is no different. Here you bring something in this
case it’s a complicated security public but again it’s like bringing a
dodgy company public that maybe you should have known better.
The underwriters should not have brought public at all because it
was such a dog.
Jill Schlesinger: But nothing illegal about it.
Yves Smith: Nothing illegal but that is also a function of the deregulation. In
fact there was an interesting proposal by the FDIC in terms of how
to change regulation of all these structure products which are much
more complex and traditional products and one of the things they
said was all of the parties. Now these has been approved one but
one of the things they really want to have happen is it all the
parties very clearly disclosed their intention. Right now you read
these documents and they contemplate so many different scenarios
and parties like Goldman is in the deal and so many different sides
that they could almost do anything and so they really want the
people like John Paulson the short seller and Goldman itself to be
very clear about what their intentions are. If you're going to be
short on the deal you're going to let your investor know that was
Jill Schlesinger: Tell me what’s the good news in all of these, I mean you’re not a
huge fun of all the pieces of regulatory refund but what’s the good
news out of this crisis and in regulatory refund with someone’s
who’s watching can say well at least they’re doing that. What’s the
good news here?
Yves Smith: Well one thing is I think we see a switch in that added to about
regulation. I mean now there is a recognition that regulation isn’t
an evil, that regulation is actually valuable and necessary so now
we’re back to debating what degree of regulation is important and I
think that’s a big positive.
Jill Schlesinger: All right I like that. I want one positive out of this whole thing.
She’s the diva of derivative. Yves Smith, thank you so much
Yves Smith: Thank you.
Jill Schlesinger: And thanks for watching.
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