Regulatory Musings at Harvard

I had the pleasure of attending a discussion as part of the Alvin Hansen Symposium on Public Policy series at Harvard this afternoon.  The topic was “Re-Regulating the U.S. Financial Markets.”  I thought my readers might be interested in some of the remarks.

I was unable to stay for the broad panel discussion at the end, but heard presentations from the two main speakers, Robert Shiller and Randall Kroszner.  Shiller’s name may be more familiar, as the author of “Irrational Exuberance,” the co-creator of the Case-Shiller Home Price Index, and the Arthur M. Okun Professor of Economics at Yale.  Kroszer’s career is equally impressive, both as an academic, serving as the Norman S. Bobins Professor of Economics at the University of Chicago Booth School of Business, and as a former Governor of the Federal Reserve.

The two distinguished presenters approached the regulatory challenges differenty, Shiller from a largely philosophical/ethical viewpoint, and Kroszner from a “nuts and bolts” policy standpoint.  The areas of common conclusion were particularly interesting.  A few highlights:

  • Both speakers viewed the crisis as a worldwide failure of risk management, both on the part of individuals as well as institutions.
  • Both emphasized the need for better consumer protections for users of financial services.  Shiller suggested that fees associated with financial advice be hourly and consumers be given a tax credit.
  • Both suggested that better structure be in place for when things go wrong.  Shiller suggested that mortgages have automatic (and ongoing) workout provisions, while Kroszner discussed the need for better resolution structures for non-bank financial institutions that get in trouble.

Kroszner went on to outline some specific areas of concern: 1) the need for private sector solutions, not just government regulations, 2) reducing the “pro-cyclicality of regulation” (regulations should slow the excesses at the frothiest tops, not clamp down when times are toughest), 3) eliminate the too-big-to-fail and too-interconnected-to-fail risks.  He spent a great deal of time reviewing the last risk, particularly the regulatory void deailing with long-dated financial contracts like the swaps market.  Kroszner supported many of the reforms that have been discussed elsewhere:  a move to a central clearinghouse for swaps and standardization of contracts. 

I thought Kroszner had some interesting observations about the ratings agencies.   He pointed out that the ratings agencies had actually been very successful in being discriminating about traditional corporate credits, giving only about 12 U.S. companies the top “AAA” rating versus 1,000s of different securitized mortgage issues that got the same top rating.  This is not a completely legitimate comparison for many reasons, but Kroszner made a good case that we should not “throw the baby out with the bathwater” — the credit ratings agencies can provide value, and he argued that they work best when transaparency allows third parties to verify their work.  The analogy would be the role that the fixed income research departments at investment banks play in keeping the  rating agencies honest by offering competing insight into coporate credit quality.

Both speakers conveyed a strong sense that capitalism and belief in free markets were being tested, and that regulatory reforms had to answer to a standard of “fairness.”  Shiller spoke explicitly about “democratizing and humanizing” finance.  These are important considerations — but also represent a few slippery slopes — one person’s “fairness” is another’s tyranny.  That being said, I appreciated the focus on the free markets and the financial industry being in the service of society and individuals.  I can only hope that our public policymakers engagement with the regulatory challenge will be even half as thoughtful as today’s discussion.  My appreciation to Harvard for allowing the public to attend.

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