Sumner on Financial Regulation

One of the most thoughtful bloggers on the recent financial crisis and what policymakers might do about it is Scott Sumner, an econ prof at Bentley University. He tends toward longer posts than are common in the blogosphere, but if you have the patience, they are well worth the time. In a recent post defending the efficient-markets hypothesis (EMH), he includes this insight:

So the anti-EMH argument for regulation must be based on the following: bankers are irrational and make lots of foolish loans. Regulators are rational and can see that these loans are too risky, and can protect bankers from hurting themselves. At a theoretical level this doesn’t even pass the laugh test. But what happened in practice? What position did the “regulators” take in this crisis? First we need to define “regulators,” who are much more than just the low-paid Federal bureaucrats that oversee the banking industry. Regulators are the watchmen, those who watch the watchmen, and those who watch those who watch the watchmen. In other words:

1. The President

2. Congress

3. The Fed

4. The media

5. Most academics

6. Nouriel Roubini

Guess how many of these institutions warned us about the sub-prime crisis. Now guess how many were encouraging banks to behave even more recklessly than they did. Unless we plan on making Roubini dictator of the world, there is zero evidence from the sub-prime crisis that simply giving regulators more power would have helped. And how do we know that even Roubini wasn’t just lucky, and might miss the next fiasco?

Scott then goes on to discuss the relationship between his perspective and the views of Richard Rorty, my old philosophy professor. Great stuff.