In the United States, there were two key decisions. The first, in the 1970's, deregulated commissions paid to stockbrokers... In response, investment banks branched into new businesses like originating and distributing complex derivative securities. They borrowed money and put it to work to sustain their profitability. This gave rise to the first causes of the crisis: the originate-and-distribute model of securitization and the extensive use of leverage.
I want to push back on this a bit. I find it hard to believe that on Wall Street, there were these lucrative side businesses just waiting to be exploited, but investment bankers would have been content to ignore them if they had retained their thick commissions on stock trades. As a historical matter, I'm sure Eichengreen is right that May Day was a spur. But it's a huge stretch to say that derivatives and originate-to-distribute wouldn't have been discovered, grown, and grown massively, if only there hadn't been a competitive squeeze on stockbroker profits.
Eichengreen's story, taken naively, might lead to the suggestion that we give financial intermediaries cushy sinecures, because, if we don't, we will have forced the poor dears to get creative and deploy financial weapons of mass destruction that destroy the world!
Financiers will destroy the world however much money you give them (it is never enough), if they have a profitable scheme for doing so and if they are not held back by regulation.
Financiers may also improve the world, in large and important ways, when they find profitable schemes for doing so. We want the financial community to innovate, we just don't want them to innovate crappily. That means that, yes, we want regulators to have some veto power over their innovations. But a bad response to this crisis would be to suggest that today's big names be given monopolistic cash cows so they can make lots of money running a museum of Wall Street, circa 1970.
Today's big names deserve to be ripped apart. They should not be granted plush monopolies. Tomorrow's big names deserve competition just as much as the next business. More so, actually. Finance should be rife with creative destruction to keep that market discipline vibe going... the "masters of the universe" must always be kept meek and terrified.
Finally, not all "financial innovation" is created alike. Collateralized, cleared, exchange-traded derivatives were a marvelous innovation. Letting poorly collateralized, opaque, nonstandard, eclectically-offset swaps grow into a large-scale financial instrument was idiotic, and was recognizably idiotic (which is why ISDA has had to work so hard and diligently to patch all the idiocies as they showed through the cracks). We desperately need good innovation, tools for intermediation that increase investor discrimination and decrease aggregate credit and counterparty risk. Sure, that's precisely the opposite of what this decade's signal innovations were all about. But developing a poison and developing the antidote are both innovation.
|Steve Randy Waldman — Monday September 22, 2008 at 6:45pm||permalink|