Saturday, April 10, 2010

Why regulators have incentive to look the other way

I think people who expect human regulators to step in and rein in the next bubble are deluding themselves. The Washington Post's Sebastian Mallaby helps elucidate the point:
As the Fed chairman in February 2000, Greenspan appeared before a Senate committee and explained why he was raising interest rates. Inflation had yet to pick up, but the powerful advance of technology stocks had fueled such strong growth that price pressure seemed likely. Of course, Greenspan could not know that he was right. ... Greenspan was greeted with a torrent of abuse. Then-Sen. Paul Sarbanes, Democrat of Maryland, charged that the Fed's preoccupation with runaway tech stocks harmed the job prospects of inner-city youths. Sen. Jim Bunning, Republican of Kentucky, railed that higher interest rates threatened the economy more than inflation. "I think people hear what you are saying and conclude that you believe that equities are overvalued," said then-Sen. Phil Gramm, the committee chairman. "I would bet that equity values, given what's going on, are not only not overvalued, but may still be undervalued."

Remember, this exchange took place in February 2000 — one month before the tech bubble spectacularly imploded. If Greenspan was assailed for raising interest rates then, imagine the reaction if he had increased rates really aggressively around 2005, when the real estate bubble was a good deal less obvious than the tech bubble had been. Or imagine the reaction if Greenspan had unleashed a regulatory clampdown on home lending in the teeth of the consensus that rising homeownership was wonderful. Regulators cannot anticipate bubbles with certainty, as Greenspan rightly says. And they may not act even when bubbles seem probable, as Krugman contends, because the lack of certainty makes it difficult to face down angry members of Congress.
While I dispute some of Mallaby's finer points, such as the housing bubble being less obvious than the tech bubble, it does demonstrate the social incentive to look the other way. As I've said before, when everybody's getting rich, nobody wants to step in and stop the party.

Human regulators are human-beings before they are regulators, and humans are naturally herd animals.


  1. "As I've said before, when everybody's getting rich, nobody wants to step in and stop the party."

    Yeah, its really a problem. Take the internet commerce for example. Its pretty much completely unregulated, and seems to work well. However if someone did try to regulate it, there would be howls of protest, YOU ARE STIFLING CREATIVITY AND GROWTH!!!

    Now imagine that some terrorists figured a way to hack in and destroy financial records of various banks, individuals, governments, everything. And I mean wipe them out - no records - nothing. Suddenly there would be howls of protest WHY DIDNT YOU REGULATE THE WEB!!!

    Either way, you cant win.

  2. James, James, James....let me appeal to your fairness here....

    1. Did I claim in my first comment that the numbers that I posted were adjusted for inflation? I used non-adjusted numbers for both India and the USA. Because you asked later if it was adjusted for inflation, I answered that in a later comment.

    2. Did I state anywhere that the income was "personal" or "household". I only said median income. I did state that the household was mostly extended family. In reality, household income is very close to personal income in India, as there is mostly only a single wage earner.

    Don't be quick to judge my calculations as "mistakes". You most probably have no idea about what is happening outside the United States. I did give you links to check out the data yourself from credible sources, so are you going to blame those as full of "mistakes" too?

    Forget everything else and ponder on this. The median price of a very nice single family home in say Chicago or LA is $400000.00. The median price of an average quality single family home in Mumbai or New Delhi is over $500000.00. Just figure out what household incomes you would associate with these cities and figure out the multiple yourself.

    Let us say that half the American families live in trailers or camp tents (and at the rate that the great nation of America is being self-destructed, that may happen sooner than you think). Will you then include the values of those trailers or tents in your "median" home price calculations?

  3. The issue becomes that at least for now, regulation is what the herd is looking for. Look at the calls for Wall Street reform. People who never even knew what regulation agencies existed are now well informed on the process by which companies are overseen by the government. For the foreseeable future, we're going to see an increase in regulation. Ideally, this will help at least slow down the rise of the next bubble as we ride the regulatory wave.

    The problem is less about lack of regulation, but rather lack of enforcement. Though it's in an unrelated field, we can look at the effectiveness of regulation by looking at the most recent mining disaster and Massey Energy. They're clearly being regulated since they owe millions of dollars in fines, but long appeals prevent them from having to actually pay ( Regulation is in place as a concept, but not as a practice.

    Human regulators may be human, and you're absolutely right that nobody wants to tell people who are making money that they can't, but now is the time that if we clamp down and regulate appropriately, we can prevent a situation where people are making too much money to sustain a market from coming up in the first place, and instead we have an even rise/fall.