Democracy at work

A sad, brilliant, devastating commentary on American democracy at work by Michael Lewis (ht: Dr. Vidyasagar) in the form of a letter from a financial sector lobbyist to his clients. Vintage Michael Lewis, of course. To this one-item reading list must be added this short piece from Gretchen Morgenson which talks of negligible progress after 3000 pages whereas Glass-Steagall took all of 34 pages.

Do not miss out on the extremely perceptive speech by Jeffrey Lacker, President of the Federal Reserve Bank of Richmond. Full text here. Key highlights below:

A compelling alternative premise, one that I personally believe is most likely to emerge as the consensus assessment among future scholars, is that the incentives created by the financial safety net were the chief cause of the financial crisis.

future assessments of the official response to the financial crisis will hinge less on the TARP and the large-scale market interventions by the Fed that followed AIG, and more on how the sequence of actions in the year before might have discouraged critical actions that firms could have taken to protect against financial distress.

While regulators have a fairly good record of preventing exact replicas of past crises, it is another matter entirely to foresee the distress that might result from the confluence of innovative financial arrangements and shocks to unanticipated macroeconomic fundamentals.

If, in a crisis, regulators remain focused on alleviating ex post distress, they are likely to err on the side of rescue and further weaken market discipline.

The expansion of the implicit safety net has been driven by the pursuit of ex post efficiency — that is, doing whatever it takes to alleviate the adverse impact of financial distress once it has occurred.11 Future economists may continue to debate whether official interventions in this crisis have achieved significant ex post efficiency gains, but our true goal ought to be ex ante efficiency, not ex post efficiency.

we will not break the cycle of regulation, by-pass, crisis and rescue until we are willing to clarify the limits to government support, and incur the short-term costs of confirming those limits, in the interest of building a stronger and durable foundation for our financial system.

Measured against this gauge, my early assessment is that progress thus far has been negligible.

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