Thursday, April 29, 2010

Finance Reform: A Bullet to the Brain

The issues underlying financial "reform" are incredibly complex. Yet, it is utterly banal, average people, with average (or less) knowledge of the subject who will pass laws to force financial practitioners to act in a certain way. Imagine a quack who could pass a law telling a dentist how to pull a tooth. Financial "reform" will be equally painful, although the pain will be spread over decades and be much harder to detect. If one needs a visualization of how regulation is simply force that negates the mind, think of that dentist and the quack-regulator.

The other consequence of the complexity of the financial mess is that it becomes nearly impossible to fight financial "reform" except at the philosophical level. Philosophically, the broad case for capitalism is made by Ayn Rand's philosophy of Objectivism. It validates reason and individual rights, the base of capitalism. However, the battle must also be fought at the level of economics, and on that level the issues are simply too complex to fight something as "real-time" as this bill.

At the level of economics, unraveling the mess means understanding how a history of financial intervention dating back to our country's founding has cumulated into the current mess. We have the consequences of the state laws against branch banking, the government's ossification of the gold standard after the Civil War, the establishment of the Federal Reserve Bank, the 1930s laws (Glass-Steagall, the SEC), government-sponsored securitization of mortgage finance (Fannie Mae and Freddie Mac, also beginning in the 1930s), Regulation Q, laws against corporate takeovers, the final abandonment of the gold standard in the late 1960s, laws that restrict the trading of derivatives on exchanges, etc.

The consequences of each of these laws can be traced, sometimes through spans of time longer than a century, all the way up to the present day. Each of them was involved in the current crisis (and each was passed in response to bad consequences stemming from the prior laws). The solution requires the repeal of all of them, and the establishment of free, private banking in a form that has never existed in this country.

This is the type of case that must be made on economic terms and is the proper context for the congressional hearings on financial reform. However, very few people can present such a case. Certainly, none of them have appeared in these hearings.

Bottom line: The quacks are going to tell those of us in finance how to practice our craft. Finance is the "brains" of capitalism. It allocates capital to where it can create the most wealth. Our economy's brain is about to take another bullet.

3 comments:

Doug Reich said...

Excellent post. You captured the essence of the issue precisely.

The layers of law and regulations that have led to the current system are an absolute mess and have caused the current crisis. Yet, as usual, more government power and "oversight" will be called for to correct the mistakes following from these laws.

When you observe this state of affairs, you realize that a practical case on the basis of the economics would never work. One needs a full moral assault on government intervention in the economy. We need the power of principled thinking which can cut through the altruist fog and the byzantine regulations to fully see why a free market is practical and moral.

It will take time, but I'm glad financial professionals like you are pointing this out. It is a start.

Galileo Blogs said...

Thanks for your comment, Doug. Without the moral argument, the case for capitalism cannot be made.

However, the economic facts do need to be laid out so that people can see that capitalism is actually practicable, in all of the details of its operation. In the area of money and finance, especially, most economists don't understand how the economy works, let alone everyone else. The problem is that it is very abstract and that the mixed economy we're in operates with an incredibly thick encrustation of regulations/interventions that obscure how it would and could work in a truly capitalist world.

But the philosophical argument is primary. Unfortunately, even a free market-oriented economist finds himself addressing philosophical issues that he is not trained to address. Most of those issues are of morality, and center on the morality of profit-making.

Some are of epistemology, and concern how economists practice their craft. Failures in the latter area prevent economists from establishing and relying upon broad, integrative principles. Without those, they endlessly re-visit old issues like a cat constantly going to its food bowl every day.

That is why economists with years of training can seriously entertain and re-visit endlessly a host of arguments that have already been proven wrong as a matter of principle: e.g., price controls (e.g., minimum wage), strategic tariffs or monetary policy to favor exports over imports, the idea of the omniscient regulator who can fine-tune economic performance, etc. The mistakes are legion and stem from failing to understand the cognitive efficacy of principles. Once established, a principle cuts through this mess. Fresh study is not necessary, for example, to prove that price controls will fail in each new situation.

Anyway, the importance of philosophy to economics (and all other sciences) is a huge topic, and one that will yield great profits to economists who are willing to study it.

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