A Perfect Storm of Ignorance

A perfect storm of ignorance? That could describe many things, including the entire human enterprise. But in this case, it refers to the constellation of actions that led up to the ongoing global economic crisis. A deep and interesting analysis from Cato:

...Given the large number of contributory factors — the Fed's low interest rates, the Community Reinvestment Act, Fannie and Freddie's actions, Basel I, the Recourse Rule, and Basel II — it has been said that the financial crisis was a perfect storm of regulatory error. But the factors I have just named do not even begin to complete the list. First, Peter Wallison has noted the prevalence of "no-recourse" laws in many states, which relieved mortgagors of financial liability if they simply walked away from a house on which they defaulted. This reassured people in financial straits that they could take on a possibly unaffordable mortgage with virtually no risk. Second, Richard Rahn has pointed out that the tax code discourages partnerships in banking (and other industries). Partnerships encourage prudence because each partner has a lot at stake if the firm goes under. Rahn's point has wider implications, for scholars such as Amar Bhidé and Jonathan Macey have underscored aspects of tax and securities law that encourage publicly held corporations such as commercial banks — as opposed to partnerships or other privately held companies — to encourage their employees to generate the short-term profits adored by equities investors. One way to generate short-term profits is to buy into an asset bubble. Third, the Basel Accords treat monies set aside against unexpected loan losses as part of banks' "Tier 2" capital, which is capped in relation to "Tier 1" capital — equity capital raised by selling shares of stock. But Bert Ely has shown in the Cato Journal that the tax code makes equity capital unnecessarily expensive. Thus banks are doubly discouraged from maintaining the capital cushion that the Basel Accords are trying to make them maintain. This litany is not exhaustive. It is meant only to convey the welter of regulations that have grown up across different parts of the economy in such immense profusion that nobody can possibly predict how they will interact with each other. We are, all of us, ignorant of the vast bulk of what the government is doing for us, and what those actions might be doing to us. That is the best explanation for how this perfect regulatory storm happened, and for why it might well happen again. _Read the entire article atCATO

The author describes how the legislators and regulators added layer upon layer of legislation and regulation on top of the pre-existing structure, without understand the regulations already in place -- and without understanding the impact of their own actions.

The problem penetrates deeply into the structure of governmental regulation.

The financial crisis was a convulsion in the corpulent body of social democracy. "Social democracy" is the modern mandate that government solve social problems as they arise. Its body is the mass of laws that grow up over time — seemingly in inverse proportion to the ability of its brain to comprehend the causes of the underlying problems.

When voters demand "action," and when legislators and regulators provide it, they are all naturally proceeding according to some theory of the cause of the problem they are trying to solve. If their theories are mistaken, the regulations may produce unintended consequences that, later on, in principle, could be recognized as mistakes and rectified. In practice, however, regulations are rarely repealed. Whatever made a mistaken regulation seem sensible to begin with will probably blind people to its unintended effects later on. Thus future regulators will tend to assume that the problem with which they are grappling is a new "excess of capitalism," not an unintended consequence of an old mistake in the regulation of capitalism.

No one wants to look deeply enough into a complex and dynamic situation. They want quick fixes that they can take to the voters and say, "See here? I fixed a big problem. Vote for me so that you can keep me on your side."

It all goes back to significant flaws in human nature, and to the failure of modern education, child-rearing, and popular society to help in correcting and compensating for these flaws. That will be the subject of a future series of postings: "the secret to the future is the substrate."