Tuesday, May 04, 2010

Low Level of Economic Literacy is Plaguing Financial Reform; Time for Grownups To Step In

"From the perspective of economic literacy, last week’s hearings before the Senate’s Permanent Subcommittee on Investigations exposed an unnerving ignorance of fundamental principles of market economics by folks who have a hand in remapping rules of finance that will be with us for a while. Flip assertions about what is and is not socially valuable reflect a confusion about our market economy that is as fundamental as knowing that George Washington was the first president of the United States. Maybe it’s human nature to get self righteous about the mistakes others make when there are even worse problems in our own back yard that we should be tending to.

The low level of economic literacy is plaguing financial reform. Reform is dangerous—it produces unintended consequences—if we don’t understand the connection between incentives and economic behavior. Folks may like to hear that someone else is to blame for the mistakes they made, but everyone knows—including those who bought houses far beyond what they could afford and then walked when the promise of endless capital gains died and including the investors who bought funky financial instruments that enabled the housing bubble out west and in Florida to inflate—that Wall Street isn’t the only culprit in the housing debacle.

Goldman was no more culpable in the housing debacle than Congress. Because Washington is mostly focused on appeasing political outrage, the financial reform legislation in its present form seems likely to do little to fix the flaws and is heavily focused on changing things that had little to do with the housing debacle.

What flaws need fixing? The financial system is highly interconnected. The bankruptcy laws need to be modified to allow for an orderly unwinding of a failing financial institution (for example, ending the exemption given derivatives has attracted some attention). No institution should be too big to fail. Public funds should not be relied on to resolve failing financial institutions.

Now that the financial reform debate is in the final innings, it’s time for the grownups to step in. In its present form, financial reform will make credit more expensive and more difficult to obtain and businesses will find it more difficult to shed risk, harming the very people we are trying to help. Done right, reform will increase transparency, allow failing institutions to fail, and not stand in the way of financial innovation that has allowed those who want to shed risk to pass it to those who seek it, an evolution that has contributed to the US economy’s robust performance in the past."

~Jim Glassman, senior economist at JPMorgan Chase

HT: Pete Friedlander


At 5/04/2010 10:36 PM, Blogger Benjamin Cole said...

It amazing how little people know about fiscal policy and our financial system, and Milton Friedman.
For example:
1. Milton Friedman thought the gold standard was stupid.
2. Milton Friedman thought the homeowner's interest tax deduction unwarranted and caused an over-allocation of capital to the housing sector--probably today he would say it helped cause the housing bubble, along wih Fannie and Freddie.
3. Milton Friedman thought the FDIC should be abolished.
4. Milton Friedman favored a progressive consumptipn tax to finance military mobilizations.
5. Milton Friedman would advocate wiping out the SEC.

And most people do not know that two-thirds of federal income taxes (as opposed to payroll taxes) are eaten up by the Department of Defense, USDA, VA, Commerce, Interior, Homeland Security and Civilian Defense, and debt payments.

With such fundamental cluelessness about true classic economic principles and the real shape of the federal budget, I see little hope we can balance the federal budget again. People want tax cuts, but regard federal outlays as sacred--especially when such outlays come into their state or district. Rural states know this fact exceedingly well.

Most "conservatives" rapidly change the subject when they find out what Milton Friedman really thought.

At 5/04/2010 10:47 PM, Anonymous Anonymous said...

If you want to know what is socially valuable, figure out how to have people own it and put it on the market.

For example there is often litle or no cost to saying "No!". If you don't want a halfway house in your neighborhood, you get a handful of people an make a ruckus, chances are it will away.

Or you could have every neighborhood required to designate a site, good bad or indifferent, and then bid for the right not to get it. The low bidder gets the halfway house - and all the money bid by the others.

Suddenly there is a price on the socially valuable "No!"

At 5/05/2010 2:16 AM, Anonymous Anonymous said...

plaguing (not plauging )

1. Words You Never
Knew Came From

Main Entry: 2plague
Function: transitive verb
Inflected Form(s): plagued; plagu·ing
Date: 15th century

1 : to smite, infest, or afflict with or as if with disease, calamity, or natural evil
2 a : to cause worry or distress to : hamper, burden b : to disturb or annoy persistently

At 5/05/2010 6:07 AM, Anonymous DIY Investor said...

The problem started with the Fed - Greenspan and Bernanke. If they had kept the fed funds rate at 3% in 2003 we would never have had the crisis we had. Greenspan was the nanny Chairman who got caught up in his own ego. Bernanke's going down the same route.
Five years from now we will have virulent inflation and we'll blame China not Fed controlled zero interest rates. The blame never goes to the culprits. In the meantime we can console ourselves by meaningless reform.

At 5/05/2010 6:23 AM, Anonymous geoih said...

Quote from Benjamin: "Most "conservatives" rapidly change the subject when they find out what Milton Friedman really thought."

The Chicago School of economics is as flawed as anything Keynes thought up. Friedman could never overcome these flaws.

At 5/05/2010 8:26 AM, Blogger Paul said...

Benji the Last True Economic Conservative,

"Most "conservatives" rapidly change the subject when they find out what Milton Friedman really thought.."

Hey Benji, what do you reckon Friedman would think of your boyfriend Barack taking over whole industries and running up trillion and a half deficits?

At 5/05/2010 10:29 AM, Anonymous gettingrational said...

I disagree that financial institutions such as Goldman had little to do with our most recent economic woes. Investment firms such as Goldman Sachs have helped make markets for bundles of mortgages. Proprietary firms such as Goldman Sachs have helped create complex trading strategies. The almalgam of bundles of mortgages and pproprietary trading resulted in complex financial instruments.

The increasing complexity obscured the bundles being sold and gave advantage to GS traders and their trading customers. The leverage of trading instruments, such as puts, can allow huge profits for little investment.

Proprietary trading against investments sold to customers, whether by house or proxy, really exacerbated and quickened a panic in faith of the securities sold.

The financial literacy of the investment bundles sold was more and more of a problem. This was probably deliberate so that an element could be used to leverage advantage. The result was that the advantage was to the house (GS) no matter how financially literate their customers were.

At 5/05/2010 12:00 PM, Anonymous Benny The Man said...

I forgot to add that MF favored taxing pollution.

At 5/05/2010 2:13 PM, Blogger juandos said...

"Low Level of Economic Literacy is Plaguing Financial Reform; Time for Grownups To Step In"...

Ahhh, the pseudo benny testamonial posting!


At 5/05/2010 6:52 PM, Anonymous grant said...

Wasn't the plan to take over the failed US companys and reinvigorate them. Then re-float them and get taxpayers money back. What went wrong.When do taxpayers get their money back?


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