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September 18, 2008

Policy Suggestions for Post-Crisis Markets

I was recently re-reading Frank Partnoy's excellent 2003 book Infectious Greed (yes, we both borrowed our names from a 2002 Alan Greenspan speech). It remains remarkably prescient with respect to the current crisis, having nailed the origins, the motivations, and the likely consequences of the move to highly levered, structured finance as a foundation for the global banking system.

Here are some of his suggestions from the book for trying to arrest the damage:

1. Treat derivatives like other financial instruments. The current system permits "regulatory arbitrage", and it needs to end before more damage is done to a teetering and badly broken system.
2. Shift from rules to standards. Over-specific rules permitted people to game the system by playing to the letter, not the spirit, of regulation. At the same time, rules are instantly self-obsoleting, as they they locked in stone and market moves on, while the regulatory regime doesn't.
3. Eliminate the oligopoly lock of gatekeepers, especially credit-rating agencies. This one's pretty much self-explanatory, and I feel equally passionate about its correctness.
4. Encourage informed investors to bet against stocks. We're going the opposite way on this one, but we need more, not less, short-sellers. While it has become marginally easier to short-sell in recent years, it is still more difficult and costly than going long. That should not be the case, as it means that when inevitable corrections come, they are savage.

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