Saturday, October 20, 2012


(h/t Chrystia Freeland in this interview with Bill Moyers)

Willem Buiter has an impressive resume in finance and economics and in 2007, described the problem with the Federal Reserve:
Throughout the four months of the crisis, it is difficult to avoid the impression that the Fed is too close to the financial markets and leading financial institutions,and too responsive to their special pleadings, to make the right decisions for the economy as a whole.

Historically, the same behaviour had characterised the Greenspan Fed. It came as something of a surprise to me that the Bernanke Fed, if not quite a clone of the Greenspan Fed, displays some of the same excess sensitivity to Wall Street concerns.

There is an always-present danger of a regulator getting too close to the industry it is supposed to be regulating in the public interest. Even if conscious regulatory capture is avoided, the regulator is at risk of internalising the objectives, fears andworldview of the regulated industry to such an extent, that it interferes with the regulator's ability to make an impartial judgement about what actions are most likely to serve its official mandate.

There can be no doubt in my view that the Fed under Greenspan treated the stability, well-being and profitability of the financial sector as an objective in its own right, regardless of whether this contributed to their legal triple mandate of maximum employment, stable prices and moderate long-term interest rates.
While the Bernanke Fed has but a short track record, its rather panicky reaction and actions since August suggest that it too may have a distorted and exaggerated view of the importance of the financial sector for macroeconomic stability. Time will tell.

In 2009, Buiter wrote a little more on this concept:
Regulatory capture is a fact of life. Regulators everywhere and at all times have been at risk of being captured by the industry or private interest they are meant to regulate in the public interest. This risk has often materialised. Such capture need not take the form of bribery, blackmail, corruption or deliberate perversion of the regulator’s mandate. It is more likely to occur through what I have called cognitive regulatory capture, the process through which those in charge of the relevant state entity internalise and adopt, as if by osmosis, the objectives, interests, fears, hopes and perception of reality of the vested sectional interest they are meant to regulate.

Our regulators must know how the financial sector thinks; they must understand its moods and mood swings, but they have to keep their distance, emotionally and intellectually. They can smoke it, as long as they don’t inhale. That’s not an easy task. Expect failures. The American SEC is a spectacular example of regulatory capture. While less easily manipulated and pushed around than the SEC, the Fed is also an example of cognitive regulatory capture.

1 comment:

Ken Hoop said...

Kucinich and Paul to the rescue.