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Wall Street Meltdown…Checks and Balances
September 16, 2008

The past two weeks have witnessed the devastation that results when the checks and balances that are critical to our economy – in the form of reasonable oversight and regulation – are removed. Unfortunately, over the past three decades (as noted here and elsewhere), the concept of regulation has come to be seen as a sort of economic strangulation...to be avoided at all cost. The New York Times called last week’s Fannie Mae / Freddie Mac bailout “a seismic event in a year of repeated financial crises followed by aggressive federal intervention.” Wouldn’t “preceded by aggressive federal intervention” be preferable?

It is easy to see these seismic events as part of the natural order of things, as a sort of corrective action that will stabilize our economy. And, while there may be merit to that argument, witness the victims of this corrective action: the secretaries, office workers and small investors who woke up today jobless, penniless or both. It takes a series of stupid decisions to destroy institutions that have weathered a century or more. Illiquid investments, market to market manipulation, inept or complicit rating agencies, massive leverage and grossly excessive executive pay are both symptoms and results of our current regulatory environment. Personally, I don’t have any sympathy for the people who made those decisions – they’ve certainly stockpiled the personal financial resources to help them muddle through (it was with no small amount of surprise and relief that I read that regulators plan to deny Fannie Mae and Freddie Mac executives the golden parachutes that tend to accompany failures such as theirs).

The economy spurs innovation and creativity in abundance, but without oversight, that energy can manifest itself as creative destruction. To be clear, I don’t believe regulation and over regulation is the answer to all of these problems…in fact, I fear that government will do what they always do…instead of reacting in a sensible and proactive manner, they will now overreact and potentially make the long term solutions worse. But, reasonable and common sense regulation is a must…the past two weeks have seen financial earthquakes that have rattled Wall Street, sent the Dow tumbling, smashed the nest eggs of thousands of bystanders…and put our economy in peril.

We have persistent issues to face here and abroad; wars, health crises, heightened competition, the list goes on. Without a robust economy, we’re hamstrung in our ability to manage these issues. And as long as a level of appropriate regulation continues to be seen as a bottleneck, our economy will continue to be held hostage to cycles of excessive greed and dislocation.

Posted by Michael Kempner at September 16, 2008 12:40 PM