Market Forces at Rest

From the New York Sun:


"The Securities and Exchange Commission can blame itself for the current crisis. That is the allegation being made by a former SEC official, Lee Pickard, who says a rule change in 2004 led to the failure of Lehman Brothers, Bear Stearns, and Merrill Lynch.

The SEC allowed five firms — the three that have collapsed plus Goldman Sachs and Morgan Stanley — to more than double the leverage** they were allowed to keep on their balance sheets and remove discounts that had been applied to the assets they had been required to keep to protect them from defaults.

Making matters worse, according to Mr. Pickard, who helped write the original rule in 1975 as director of the SEC's trading and markets division, is a move by the SEC this month to further erode the restraints on surviving broker-dealers by withdrawing requirements that they maintain a certain level of rating from the ratings agencies.

"They constructed a mechanism that simply didn't work," Mr. Pickard said. "The proof is in the pudding — three of the five broker-dealers have blown up.""

~~~~~~~~~~~~~~~~~~~~~~~~~~
(** Leverage in this case refers to the ratio of debt to net capital. The SEC allowed these firms to go from 12:1 to 30:1 or 40:1. This is roughly like saying that if you have $50,000 in paper assets, it's perfectly acceptable to be $2,000,000 in debt.)
~~~~~~~~~~~~~~~~~~~~~~~~~~

So, let's see -- the argument for deregulation has always been that "Market forces will determine what's best", arguing that "All of us together aren't nearly as dumb as each of us individually". Anyone who's ever been in a meeting will know differently.




Strangely enough those arguing the loudest for this theory were also writing checks to congress and presidential campaigns.

Daniel Kahneman (a psychologist) won the Nobel Prize in economics in 2002 by being instrumental in the development of behavioral economics ("Each of us individually is pretty dumb or at least pretty gullible, and so is all of us together except in a larger way"). This implicitly flies in the face of the free markets argument -- the free market won't do what's best, it will do what's immediately gratifying as humans most often do.

So, under the guise of "free markets" you remove any sort of regulation, allow the sale of promissory notes as solid assets and reduce capital requirements and the actual result isn't what's "good" for the country, the economy, or the world, it's what's immediately gratifying.

The actual result has been the privatization of profits and socialization of losses, and a stratification of income not seen since before the first world war. I'm sure that this has been most immediately gratifying for about 0.6% of the country, those with the big checkbooks. Thank you Mr. Bush, Mr. Clinton, Mr. Bush, and Mr. Reagan most of all.

The next time you step on an airplane, remember that industry is treated the same way despite the FAA's efforts to maintain safety (look for speed tape on the wings). The next time you step on the brakes in your car, remember that the Department of Transportation still requires that they actually work rather than depending on "market forces" to counteract the forces of physics. Would that the SEC had supplied proper brakes as well.