Richard Posner on Financial Regulatory Reform and the Politics of Denial

Richard Posner’s essay “Financial Regulatory Reform: The Politics of Denial,” included in The Economists’ Voice 2.0: The Economists’ Voice 2.0: The Financial Crisis, Health Care Reform, and More, explores the question of whether, as is the case, those officials complicit in the causes of the financial crisis write the reforms. In the article, Posner explores some of the causes and then argues that we should not be swayed by passions, populist or otherwise, in reforming the financial system but also should find some new experts when the time comes.

Here is an excerpt from “Financial Regulatory Reform: The Politics of Denial”:

The likeliest explanation for why these regulatory failures are be­ing ignored is that the government’s senior economic officials—Ben Bernanke, Timothy Geithner, and Lawrence Summers—were im­plicated in the failures and therefore do not want to draw attention to them. We are in the presence of the politics of denial….

Summers and Geithner, along with Robert Rubin (Rubin and Summers being in succession Secretaries of the Treasury in the Clin­ton administration), were complacent about the growing risk-taking of banks and other financial intermediaries and opposed the regula­tion of credit-default swaps, now recognized to have contributed to the financial collapse. Even though housing prices began their long, steep decline early in 2006 and the banking industry (especially the “shadow banking” industry of broker-dealers and other “nonbank banks”) was known to be very heavily invested in mortgage lending, the Federal Reserve, the SEC, and other regulators of financial prac­tices and products did little to avert financial disaster because they underestimated the looming losses to banks’ loan portfolios as housing prices fell and defaults rose. Until Lehman Brothers collapsed, the regulators didn’t realize how serious the situation was, even though the financial collapse had been building since the middle of 2007 and accelerating since March 2008, when Bear Stearns collapsed….

SHOULD OFFICIALS COMPLICIT IN THE CAUSES OF THE CRISIS WRITE THE REFORMS?

Our reform-minded officials need a better understanding of the causes of the 2008 financial collapse, and for that they need to look inward. It is a bad sign that Bernanke and the others refuse to ac­knowledge their own contribution to the collapse. It is another bad sign that proposals for ambitious regulatory reform have been made, and are being pressed, before the financial crisis has run its course and before there has been an impartial, in-depth study of the causes of the crisis. I have given my own view of those causes in this chapter and at greater length in my book (Posner 2009), but I do not claim that it is definitive. Congress has appointed a Financial Crisis Inquiry Com­mission (FCIC) to conduct an eighteen-month study of those causes, and reform proposals should be tabled until the study is completed and evaluated—that, or a better study. For I have no great hopes for the FCIC. It is bipartisan rather than nonpartisan, none of its mem­bers is a professional economist, and its executive director is a prose­cutor. It is likely to embrace the populist theory of the crisis without adequate reflection.

Fortunately there is no great urgency about restructuring the financial regulatory system. Everyone in the system, public and private, is hyperalert to signs of new bubbles and excessive risk- taking. Everyone on the private side is concerned to avoid the kind of risk-triggered failure that invites a government takeover and a con­gressional inquisition, and everyone on the public side is concerned with steering the economic recovery between the Scylla of economic stagnation (even deflation) and the Charybdis of runaway inflation.

Let us see how the recovery proceeds. There will be time enough to address issues of financial regulatory reform when a restored econ­omy enables such issues to be addressed candidly, not defensively; professionally, not angrily; patiently, not hastily—and by a fresh team, unembarrassed and unconstrained by past errors.