Day: October 19, 2008

Baseline Scenario, 10/20/08

Baseline Scenario, October 20, 2008
By Peter Boone, Simon Johnson, and James Kwak, copyright of the authors
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The Baseline Scenario is our periodic overview of the current state of the global economy and our policy proposals. It includes three sections:

  1. Updates that have caused us to modify the baseline since the last version
  2. Analysis of the current situation and how we got here
  3. Policy proposals

Please note that we do not currently publish our upside and downside risk scenarios in detail.

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UPDATES

This edition of the Baseline Scenario has been extensively updated to reflect recent events, in particular the adoption by the world’s leading economic powers of the first two of our proposals in our original Baseline Scenario.

Continue reading “Baseline Scenario, 10/20/08” →

Capitalism = Government Intervention

OK, that may be an overstatement. When I was in graduate school, I was a “reader” (meaning I graded exams) for a course on recent US history taught by Richard Abrams. What I took away from that course was that virtually all government intervention in or regulation of the economy was done at the request of some part of the business community – most often entrenched incumbents lobbying the government for protection from new entrants.

Colleen Dunlavy of the University of Wisconsin has a blog post about the history of government intervention in the economy. Most critics of government intervention take one or both of two positions: (a) it doesn’t work or (b) it’s un-American (read: socialist). Dunlavy pretty much destroys argument (b) and, along the way, gets in some blows to argument (a). It’s useful reading as we head into a season of expanded government intervention and regulation in the financial sector.

Regulating the Financial Sector: A Modest Proposal

Building a new regulatory structure for the financial sector to replace the current, completely discredit regulatory structure will be a major task for the next administration and congress. However, at present there is a wide range of opinion over what needs to be done – believe it or not, there are those out there who think that what we need is less regulation rather than more. We’ll be pointing out serious proposals that we find out there. Note that linking does not necessarily constitute endorsement.

James Crotty and Gerald Epstein of the University of Massachusetts have put forth their nine-point plan for financial system regulation (abstract online, or download the PDF – it’s only 13 pages). Most economists (though perhaps not most people) would classify them somewhere on the heavy-handed end of the spectrum. The nine points, in summary, are:

  1. Restrict or eliminate off-balance sheet vehicles
  2. Require due diligence by creators of complex structured financial products (so if you create a CDO, you have to understand all the stuff in it)
  3. Prohibit the sale of financial securities that are too complex to be sold on exchanges
  4. Transform financial firm incentive structures that induce excessive risk-taking (so people who get big bonuses in good years have to pay them back in bad years)
  5. Extend regulatory over-sight to the “shadow banking system” (hedge funds, private equity, special investment vehicles)
  6. Implement a financial pre-cautionary principle (like with drugs, innovations have to be approved first)
  7. Restrict the growth of financial assets through counter-cyclical capital requirements (um … read the proposal yourself)
  8. Implement lender-of-last-resort actions with a sting (punish the people responsible when you bail out their companies)
  9. Create a bailout fund financed by Wall Street (use a securities transaction tax to create a bailout fund to use next time)

I’m skeptical about 4 and 8 – human ingenuity is perhaps nowhere so unparalleled as in the creation of executive compensation schemes designed to avoid any possible constraint. 3 and 6 will be extremely controversial and can be seen as infringements on freedom of contract, at least where “sophisticated” investors are concerned. 9 is also controversial, although a variant of it was actually in the $700 billion bailout bill. But it doesn’t hurt to start thinking about it now.