The end of global deregulatory reform

by Henry on September 18, 2008

“Tyler Cowen”: points to this “NYT article”: on the international fallout from the current market crisis in the US.

Is the United States no longer the global beacon of unfettered, free-market capitalism? In extending a last-minute $85 billion lifeline to American International Group, the troubled insurer, Washington has not only turned away from decades of rhetoric about the virtues of the free market and the dangers of government intervention, but it has also probably undercut future American efforts to promote such policies abroad.

“I fear the government has passed the point of no return,” said Ron Chernow, a leading American financial historian. “We have the irony of a free-market administration doing things that the most liberal Democratic administration would never have been doing in its wildest dreams.” …

Mr. Monti said that past financial crises in Asia, Russia and Mexico brought government to the fore, “but this is the first time it’s in the heart of capitalism, which is enormously more damaging in terms of the credibility of the market economy.”

I could sort-of-plausibly claim that “I told you so back in March”:, but, like everyone else, I grossly underestimated the future and continuing consequences of the unraveling of the US credit markets. This is a genuinely epochal moment in US politics. But it has equally significant implications for the global political economy.

The last three decades have seen two important shifts among advanced industrialized economies. The first is the move away from state ownership of large chunks of the economy, and the replacement of hands-on government control with a variety of regulatory instruments. This has happened across all countries in the industrialized world – there are few developed states which still directly own substantial parts of their economy. The second is more specific and recent – the tendency to replace ‘heavy-handed’ forms of regulation with ‘regulation with a light touch’ and self-regulation. This has been most marked in Anglo-American economies, but other countries (in continental Europe and elsewhere) have faced persistent ideological pressures to move in this direction. This is a large chunk of the so-called ‘reform’ agenda that the Economist magazine, the OECD and other such bodies keep pushing. Both of these shifts are largely ideological – that is, they gained much of their impetus from changes in the ideas which constitute policy-makers’ shared collective wisdom about how to deal with the economy.

The second shift (the reform agenda) is now a busted flush. Its proponents are in disarray (if I’m feeling in a vindictive mood, I may well buy a copy of the next Economist to see how its editorialists try to rationalize all of this). But what is utterly startling to me is that the first bit – the claim that the state shouldn’t be directly involved in running the economy – is under serious threat too. I genuinely hadn’t expected this to happen. As the NYT notes, countries like France are using US actions as a way to justify state involvement in picking and supporting national champions. In a couple of years, perhaps we’ll see a new version of ‘le Plan’ (I’m half-joking here – but only half-joking). As Tyler says:

The economic fallout from these events is dominating the headlines. The intellectual and ideological fallout we are just beginning to contemplate.

Mark Blyth’s book, “Great Transformations”: has a theory of the relationship between economic crises and economic ideas. Very roughly speaking, when a crisis occurs that is difficult or impossible for the prevailing wisdom to explain or deal with, intellectual entrepreneurs have an opportunity to create a new (partly self-reinforcing) collective wisdom. We’re most likely in just such a crisis now. Which set of intellectual entrepreneurs are going to succeed in reshaping a new collective wisdom – economic nationalists like Sarkozy and Putin, social democratic globalizers like Dani Rodrik, or some other crowd entirely – I have no idea.



Kieran 09.18.08 at 1:58 pm

I may well buy a copy of the next Economist to see how its editorialists try to rationalize all of this

I believe the usual strategy is to assert that the problem was that the markets would have corrected themselves more quickly if only they had been left alone, that intervention exacerbated rather than alleviated the crisis (e.g., by creating moral hazard), and that the solution, as always, is more and freer markets.


tom s. 09.18.08 at 2:18 pm

Absolutely right. I’ve seen a bunch of eschatalogical commentary – the end of independent investment banks, the end of Big Bonuses, and (yesterday and today) the end of Friedman. About damn time. If this is 1976-1978 for the economic right, well that’s an opening the left has to use. I hope there is something more interesting in the air than going back to the ’50s though.


Hidari 09.18.08 at 2:30 pm

I think the great minds of our time who blog at Samizdata have an answer to your question in this quote:

Of the meltdown: ‘ I just hope that politicians resist the urge to lock the door after the horse has bolted by imposing new reams of pointless legislation. ‘ (Jonathan Pearce).

So there you have it.


belle le triste 09.18.08 at 2:54 pm

for a rather terrific redux of pass-the-buck/balloon-goes-up style erm ‘analysis’, see the Editor’s Letter in today’s “cityAM” (the london free sheet that every lunchtime litters buses round the square mile); it’s headed “POLITICIANS AND CENTRAL BANKERS DESERVE THE MOST BLAME”, begins with a long and rather baffling trope about the latin name of the Black Death, sideswipes Alan Greenspan and Gordon Brown in the middle, and ends thus, in rising (and unproofed) hysteria: “It would be tempting to pin all our the blame on the City, just as our 14th century ancestors held witches, foreigner [sic] or leppers [sic sic] responsible. that would be a terrible mistake. Bankers behaved stupidly, but they were merely the conduit for flawed economic policies. As the anger builds, we mustn’t lose our faith in capitalism.”

The bus was actually in Threadneedle Street as I read that last sentence, and I fear I laughed out loud…


Luis Enrique 09.18.08 at 2:55 pm

Are you so sure that a titantic market failure in the financial sector necessarily calls for a major revision of The Economist’s world view? As opposed to just revising it’s view on banking regulation? Even that, I’m not sure about …. has The Economist been in denial of market failures, of perverse incentives, and so forth, within banking? Your portrait is hard to square with editorials like this or this and this special report all of which, as far as I can see, discuss the need for greater and better regulation – and nowhere did I see the argument that less intervention and more, freer markets, are the answer. Although they discuss how regulation is difficult and often ineffective – who can argue with that?


stuart 09.18.08 at 3:06 pm

Surely it is fairly intuitive that a mixed economy is going to be the most stable anyway – the more extreme an economy gets towards private or public control, the more power comes down to just a few people, and that amplifies the mistakes they make. Sure in some theoretical economic world of perfect competition small or neglible government intervention might be possible, but in the real world you have corporate CEOs and Hedge Fund Managers who have more power (in some senses) than the US President, and mistakes they make can be just as damaging.


richart 09.18.08 at 3:08 pm

this idea of sea change in state control of substantial parts of the economy almost makes sense if you blind yourself to the US defense & intel budgets…


someguy 09.18.08 at 3:08 pm

What is happening really doesn’t vindicate or disprove this or that ideology.

There is a lot of baseless crowing about how it does from all sides.

I don’t see a liberterian or socialist revolution as the cure to all our ails and more importantly they aren’t happening.

Since there is no chance we won’t be bailing out this or that financial firm in fore seeable future. It makes sense that we discuss how to prevent this from happening again. Including regulating sectors that are not currently regulated. But regulation is not a panacea and neither is nationalization.

If discusing over sight from this or that regulation to nationalization equals the death of naked, brutal, and unfettered capitalism and the triumph of Social Democracy well then score one for Social Democracy and can we get on with discussing the oversight?

I would like a better understanding of what is happening and more discussion about possible solutions.

I wonder why no one is doing an open thread on this? I would think I lot of people have a lot of questions and a bunch more have a lot of information.


mpowell 09.18.08 at 3:24 pm

It would be a shame if this led to state ownership or direction on main street. That would be silly. The problem is pretty clearly confined to the financial markets. Obviously, we need to seriously reconsider the way banking institutions function.

(On a side note: I think more and better regulation on main street would be good for society, but there’s nothing to indicate a crisis in the way those businesses operate, generate wealth and so forth)


lemuel pitkin 09.18.08 at 3:25 pm

From yesterday’s FT: “If financial behemoths like AIG are too large and/or too interconnected to fail but not too smart to get themselves into situations where they need to be bailed out, then what is the case for letting private firms engage in such kinds of activities in the first place?”


Ano 09.18.08 at 3:58 pm

The Economist doesn’t seem to be behaving as predicted:

It might be good, in theory, to let an investment bank fail “to encourage the others” and to buff America’s tarnished reputation as a champion of free markets. But having gone to such lengths to boost confidence in the financial system, the authorities will be reluctant to take that risk. It does not help that financial products are now so complex that it is very hard to make even an educated guess about the real value of a bank…. But the rescue of Fannie and Freddie and the travails at Lehman are merely the latest in a long series of tests that the authorities will have to face over the next year or so. With Fannie and Freddie, they eventually passed the test. They may have to act more quickly and decisively next time.

Sounds kind of regulation-y to me!


Ano 09.18.08 at 3:59 pm


Markup 09.18.08 at 4:22 pm

The problem is pretty clearly confined to the financial markets. Obviously, we need to seriously reconsider the way banking institutions function.

Huh, and huh?

For expediency, “It” is not ‘a’ problem, of which we are seeing the results of in the financial sector, unless of course your long term time horizon doubles every 9 to 26 weeks, but rather a cascade of them and this is the spring run off following a larger than average snowpack that was preceded by a long stretch of below average to drought conditions. Much disappeared from the daily consciousness. Oh, the shock!

There will never be a “free market” so long as people and nations run by people are involved. What exactly is a farm subsidy for example; thousands of miles of public financed access roads, direct cash payments, free fertilizer for 5 acre plots? Does economics adhere to Lomonosov-Lavoisier with more quantum exemptions for “freeness”? All these great recent market innovations have done is to bear out that there much can be said about certain fallacies of the ‘creation’ of wealth.


Mr Art 09.18.08 at 4:30 pm

And yet… it was the (relatively) lightly regulated hedge funds that survived this crisis without bail-out.

Rewind two years: the bleating was not about systemic risk in the investment banking sector.

This crisis is overblown. Wake me when unemployment hits 20%.


Markup 09.18.08 at 5:12 pm

What is your time reference for “this crisis”?

Where are the buyers of LTCM now, they’re doing well I suppose, and no doubt that too is trickling down?

Rewind two years: the bleating was not about systemic risk in the investment banking sector….Wake me when unemployment hits 20%.

T’was by some, even before that, but I reckon it’s a matter of which pen or paddock one was in at the time. Lucky guess I suppose. It’s good to know some can remain calm during the storm that Rewind said wasn’t going to/couldn’t happen two years ago.

Seems obvious to me that there’s been some severe storm damage when Lady Lynn Forester de Rothschild says of Obama with straight face, “I feel like he is an elitist.”


HH 09.18.08 at 5:16 pm

There appears to be something intrinsic to organizational growth that degrades the quality of decision making. Once a company becomes so large that it relies on aggregate profitability, the quality of leadership in any one unit becomes a negligible issue. Top management drifts into a cult of personality and meritocracy vanishes.

Thus, the repeated breaking up of faltering business monoliths into healthy fragments seems to be a necessary duty of government. The US is doing exactly the reverse by preserving dysfunctional corporate monstrosities and rewarding them for failure.


mpowell 09.18.08 at 5:16 pm

13: What are you talking about? The performance of companies vary. Some, like Google and Apple, have been doing very well. Some like, Ford and GM have not. But a collapse of GM does not risk triggering widespread collapses and economic callamity. The situation with the financial sector appears very dangerous indeed. Sure, it was triggered by the real estate bubble, which was covering for poor wage growth, but that’s just the point isn’t it? The functioning of the financial sector first enabled the excessive real estate bubble. And then when it burst, it turns out that the controls in place to try and prevent widespread collapse in the financial markets in the case of such an event, were not sufficient. And without properly functioning financial markets, the rest of the economy will suffer.


Luis Enrique 09.18.08 at 5:47 pm

well, here a set of articles from the latest Economist. Any vindictive pleasure to be had from that?


almostinfamous 09.18.08 at 5:59 pm

Rewind two years: the bleating was not about systemic risk in the investment banking sector.

ever heard of one guy callednouriel roubini?
people who warned about any risk, let alone systemic were ignored or swept under the carpet. the sneering tone of the article in general kinda tells you the mood 2 months back, which was that stearns was just a bad apple, when the whole basket was dripping rotten.


Markup 09.18.08 at 6:12 pm

But a collapse of GM does not risk triggering widespread collapses and economic callamity.

So further bailout[s] for the big 3 are out?

Sure, it was triggered by the real estate bubble, which was covering for poor wage growth, but that’s just the point isn’t it?

So all the pushing for lax reg’s and enforcement, somewhat meaningless “reforms” after the prior bubble, changes in bankruptcy law, etc., are/were not related, rather it is happening because our benevolent money traders wanted to ease the sting of stagnant wages? Seems I’ve been drinking the wrong bubbly.

What are you talking about?

…without properly functioning financial markets, the rest of the economy will suffer

Not quite sure I get the point of your first Q, but you finish up nice at the end. Seems rather obvious now to most that the markets are tripping over themselves; who’s sneezing and who is catching cold?

If I go out and survey a two hundred year old structure to aid in determining its future and possible sue for the next 200, there are a number of factors and processes I must use to move forward. Regularly I run in to the problem where the costs to do the foundation repairs get moved way down the priority list because they might hold up for another 20 or 30, and getting the main facade back in order gets placed to the top. In some cases that works out well, but primarily owing to luck. There are always external “unforeseen” forces at work [broken water/sewer main, extraordinary freeze/thaw cycles, significant wind stress…]. Sure it’s still just risk evaluation, and I don’t really need a new set of building codes to proscribe which action to take, but alas I’m not the only player.

Mr Art above was I think making a hint with his comment, “And yet… it was the (relatively) lightly regulated hedge funds that survived this crisis without bail-out.” Of course we don’t know yet where they will all land, and he somehow forgot to include them as players in the various schemes we now are getting our collective comeupance on.


David Weman 09.18.08 at 6:17 pm

One month, you mean.


David Weman 09.18.08 at 6:21 pm

21 to 19.


Markup 09.18.08 at 6:30 pm

the bleating was not about systemic risk in the investment banking sector.

Bhaaaa, breathtaking.

June 26, 2006

Remarks of Emil W. Henry, Jr.
Assistant Secretary for Financial Institutions
U.S. Department of the Treasury
At the outset, let me be clear on the meaning of systemic risk: it is the potential for the financial distress of a particular firm or group of firms to trigger broad spillover effects in financial markets, further triggering wrenching dislocations that affect broad economic performance. Perhaps a useful analogy is to think about systemic risk as an illness that can become highly contagious.
Systemic events can unfold by direct and/or indirect spillovers. Direct spillovers arise when the failure of a particular firm creates substantial losses for those who carry direct exposure with such firm, such as its creditors. Indirect spillovers typically develop, not from direct exposures to the firm at the epicenter of the crisis, but when this firm causes a lack of confidence leading to a sense of panic and turbulence that results in action that generates substantial losses for firms that were not directly exposed to the impaired firm. Such spillovers � not the initial event — typically take the greatest toll on economic activity and, in the case of the GSEs, the potential for both direct and indirect spillover effects is nothing short of breathtaking

Sorry, no time to run the the other several hundred thousand hits on the Google to whittle down to the several or tens of thousands relevant. Mission accomplished?


Mr Art 09.18.08 at 7:38 pm

@23: your quote makes no reference to the investment banking sector, though it does mention GSEs.

My point was just that of the potentially risky areas, most commentators (the admirable nouriel roubini excepted) would have fingered hedge funds and perhaps private equity as those requiring more regulation.

Don’t get me wrong. I support more regulation so that taxpayers aren’t again on the hook for these clowns’ mistakes. But what kind of regulation? Banning short selling seems like a terrible idea – it just postpones the inevitable.

And with all the talk of financial apocalyse, the real economy isn’t doing too badly (so far). Anyone who said there’d never be another recession is an idiot.

PS for the record I’ve been boring my friends about the housing bubble since 2003.


Markup 09.18.08 at 8:06 pm

Here’s the link to the whole text.
The important part of the quote was, “Perhaps a useful analogy is to think about systemic risk as an illness that can become highly contagious.
[…] spillovers.” Note how he refers back to the S&L fun times. There are dots to connect. Re-regulation will be a tough one since big money always gets more sway and that’s changing hands now faster than a campaign talking point reversal. One lesson we should be starting to get is that money has a tendency to corrupt the process of regulating [esp] money [duh]. Seems to me that the first thing is to revise the tax structure so the short term gamers who play the system like a Vegas card counter are not rewarded as they are now. 1 day =90%, 3 = 80% … 365 =25%, 1095 = 15%, 5 years or longer say 7.5% be it Wall St or your street [house].


Markup 09.18.08 at 10:45 pm

Here are some more thoughts on “The Financial Re-Regulatory Agenda”


Joshua Holmes 09.18.08 at 11:24 pm

Frankly, I find a lot of this confusing. One point of having markets is that, on occasion, a firm may make a spectacularly bad mistake and go under, just as, on occasion, a firm may make a spectacularly smart move and profit immensely. These collapsing firms all made spectacularly bad mistakes and should go under. We’ve all learned something about the usefulness of the bond credit ratings, not to bet on bubbles, and not to leverage yourself into a crystal palace on a toothpick. Hopefully, we’ve learned something about paper money, too, but I think that lesson is only for us hardcores.


Ginger Yellow 09.19.08 at 3:39 am

Belle le Triste: CityAM had nothing on the Daily Express, which ran an editorial titled Don’t let the spivs destroy Britain. At the end of a fairly standard tirade against the excesses of high finance, it veers off into a classic Daily Express non-sequitur about the evils of the undeserving poor:

The lives of hard-working people in Britain are increasingly blighted by a feckless underclass whose indolence they are forced to bankroll through the tax and benefits system and a ruthless overclass which siphons off billions.

Unless action is taken to stop all these spivs in their tracks, decent people will lose faith in the dynamism of free enterprise and the moral imperative of striving for self-reliance.

It is a horrible thought but the greed of a few bankers and corporate fat cats could hand an undeserved lifeline to the failed creed of State socialism. It must not be allowed to happen.


Ginger Yellow 09.19.08 at 3:40 am

Damn. All three of those paragraphs should be in the blockquote.


jim in austin 09.19.08 at 3:56 am

If you are too large to fail does it not follow that you are also too large to be allowed the possibility of failure, whether enforced through regulation, nationalization or dismemberment?


John Quiggin 09.19.08 at 5:00 am

“And yet… it was the (relatively) lightly regulated hedge funds that survived this crisis without bail-out.”

Half true. At least there haven’t been large scale direct bailouts of hedge funds so far, but they are failing at a steady clip despite benefitting from the massive infusions of liquidity being thrown at the system as a whole. If you can remember back to 2007, it was the failure of hedge funds link to Bear Stearns that signalled the extension of the crisis beyond the subprime mortgage sector.


felix culpa 09.19.08 at 6:04 am

this idea of sea change in state control of substantial parts of the economy almost makes sense if you blind yourself to the US defense & intel budgets…
Richart and I are of a nearly single mind here. A piece by Noah Millman at American Scene closing with “The renovation after the fire is going to take years. Anyone who confidently tells you they know what it’s going to look like once that process is done has been paying as little attention to the financial crisis as, say, Sarah Palin has been paying to foreign policy.” was my inspiration.
Where R and I differ was I wasn’t thinking about state control (nothing unusual for me) of parts of the economy, I was just thinking it was going to work a lot differently if there were a lot more poor people; there are a lot of very bright poor people, though ill-adapted to an environment governed by money. A lot of PhD’s, I gather, and all those proverbial grad students, all manner of intelligences ill-suited to flourishing under the present terms of exchange.
Poor people, who have on-the-ground knowledge of being poor, and with their embedded intelligentsia understand issues surrounding survival that will be newly important to the culture at large. The poor will speak with confident authority to the erstwhile nominal captains of Commerce, who could at such a point only utter stuttering croaks, blushing the while. And a little child shall lead them.
And then I thought, like richart, that it would work, as long as the hyper-industry serving the arts of armed barbarity and the petrochemical octopus were to pass quietly from our shores and leave all their money.
So I figured the sea-change might not be very nice.

I’m sticking with stochastic contingency.
And I pray a lot.


sg 09.19.08 at 7:26 am


Ginger Yellow, this is completely off-topic, but I have been in London 3 months and in that time I have been shafted in every possible way by the “decent hard-working” people of London. Throw the damn lot of them on the dole and replace them with someone who actually knows how to do their job, most probably a feckless foreigner – and string up all tabloid editors who think that the “decent hard working” British person is anything but an incompetent fool.

I would send my manufacturing business offshore in the blink of an eye if I had to deal with the British worker. And given the incompetence of everyone from the toilet cleaners right up to their bank managers, it hardly surprises me that the higher echelons I don’t deal with are incompetent fools as well.

It appears to be a condition of the British workplace that it is dirty, rude, the staff can’t spell your name, they lose your money, send your parcels to the wrong address, cannot redirect mail, don’t understand their own business processes, sell your contact details to criminal gangs, and lie about every mistake they make because it’s easier than taking 10 seconds to correct it. And yes, they can’t even put paper towels into the holders properly when (if) they clean the toilets. These are not people I would trust with 1 trillion pounds of credit derivatives!


Lex 09.19.08 at 12:10 pm

@28: that’s hysterical. Literally, of course.

It’s also a line of thought that goes all the way back to Rousseau’s Social Contract, with its urge to “allow neither rich men nor beggars”, for the latter will sell public liberty to the former at the first opportunity.

Which all goes to show that petty-bourgeois crypto-fascism has a long and distinguished past, and probably a vibrant future, alas…

@33: Blimey, what happened? Walk into a Guy Ritchie movie by mistake?


sg 09.19.08 at 4:21 pm

Lex, everything in that last paragraph has happened to me just in the last month. At least in a guy ritchie movie a couple of the gangsters are competent.

No wonder their housing and financial markets are falling apart.


HH 09.19.08 at 5:18 pm

The reason our Internet facilities function so well is that they were not developed by liars. Other institutional structures are not so fortunate.


Markup 09.19.08 at 6:19 pm

“Internet facilities function”

That could use some clarification. Oh BTW could you help me with a little problem I’m having with importing 7 kg of rough gem quality diamonds? See what happened is my bank in South Africa got hit with all this market unrest and my funds for the export duty was frozen with that of many other companies. In short if you could wire the $7,400 [US] to my other account, once the diamonds are back here I will repay you plus a bonus of $40,000 [US]; if you can do this before close of business today I can also add unlimited free porn for life, 25,000 unexercised John Scanlon Jan. 2002 options, and a face to face with Al Gore the inventor.

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