[OPE] The (self-) regulation of capital and the morality of risk-taking

From: Jurriaan Bendien (adsl675281@tiscali.nl)
Date: Sat Mar 29 2008 - 17:08:00 EDT

Treasury secretary Henry Paulson says something interesting:

"I am not suggesting that more regulation is the answer, or even that more effective regulation can prevent the periods of financial market stress that seem to occur every 5 to 10 years," Mr. Paulson will say in a speech on Monday, according to a draft. "I am suggesting that we should and can have a structure that is designed for the world we live in, one that is more flexible. (...) The United States has the strongest and most liquid capital markets in the world." http://www.nytimes.com/2008/03/29/business/29regulate.html?_r=1&hp&oref=slogin
Implicitly this acknowledges that the state is nowadays rather limited in regulating capital movements as such, whatever its political biases might be. The genie is out of the bottle. The state could prohibit certain transactions, but even if doing that was enforcible, capitalists would find a way around it. 

The "regulation" regime proposed by Paulson seems to have three main thrusts: 

1) centralization of overseeing bodies, 

2) greater powers of state scrutiny of financial institutions, 

3) "veto power", i.e. the ability to place financial institutions in curatele, if they flout the rules and engage in dodgy business. 

The delicate problem is, that "disclosure" of financial dealings may harm business interests, whose very ability to make money precisely depend on information privacy. That is the well-nigh insurmountable problem of the Financial Stability Forum.

The underlying regulatory philosophy seems to be (although they probably wouldn't put it that way) that if unsound (too risky) financial practices occur, this will lead to losses, and then businesses will be forced to regulate themselves - so the only regulation that is really essential, is that which prevents "systemic risks" (i.e. unsustainable losses from the point of view of society). This is still well within the ideology of neo-liberalism. All it says is that the state will be the supreme judge or caretaker of acceptable risk-taking. For example, invading Iraq is an "acceptable risk".

The core problem for the regulators is the inherent logical paradoxes of concepts of risk and risk management themselves, since those concepts are difficult to categorize uniformly, to define exhaustively and to measure accurately - whether scientifically or legally - (they intrinsically involve some subjective interpretation), while the fund managers precisely depend on innovative risk-taking to make money (I have discussed this a little in my somewhat satirical post previously, on John McCain and banking risks). Since innovation means doing something that is new and unprecedented, it is difficult to legislate for that in advance.

Thus, the Hedge Fund Working Group does not get much beyond generalities which can be interpreted in all sorts of ways. As far as risk management goes, they emphasize integrity (a firm must conduct its business with integrity), management control (a firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems), financial prudence (a firm must maintain adequate financial resources) and customers' interests (a firm must pay due regard to the interests of its customers and treat them fairly). http://www.pellin.co.uk/HFWG/Final-Report.pdf 

That is a sort of morality of risk-taking based on reputation and track record, but the problem there is, that there exists nothing which can ensure that these principles will be uniformly interpreted by all, and it is not feasible to define exhaustively how they should be interpreted. At most you can establish whether most people currently regard a particular practice as risky at some level. 

Regulating risk itself would be like standing at a casino table, and telling players "you cannot make that particular bet, because it is irresponsible". You would have to write probability theory into the law, but even if this was possible, it would contravene the jurisprudential principle that the law must be able to state categorical absolutes - it must always be able to define and prove consistently what is right and wrong, in advance of action, since you cannot reasonably obey a rule or be found guilty for disobeying it, if the rule is adjudicated only after you have done something. For example, if the Supreme Court ruled that invading Iraq is wrong beecause it is too risky, you cannot be found guilty if you invaded Iraq beforehand, because there was no rule then which said you could not do it.

The logical conclusion of all this, is not merely that state regulation of financial dealings is in principle undesirable, but that it is in large part really impossible, and that is what Paulson is responding to; his regulatory scheme basically says that "if it turns out you did it wrong, there will be penalties". This in turn reinforces the idea that the winds of the "economic weather" are really uncontrollable. Thus, for instance, David Rosenberg wrote in the FT:

"(...) Stagflation is yesterday's story. Tomorrow's story is very likely to be deflation. We are already seeing hints of this - housing, equities, now commercial real estate and it looks like oil and industrial commodity prices are rolling over in a rather material way. The dollar now seems to be consolidating. I would not be surprised to see the inflation rate, total and core, flirting with 1 per cent levels by 2009. (...) I'm not sure that cyclical downturns are "inevitable" but it does stand to reason that recessions are as much a part of the business cycle as expansions are. In fact, there have been 32 expansions since the Civil War and funnily enough, there have been the same number of recessions. They are joined at the hip, and it's a good thing that expansions are long and recessions are short, but what recessions do is they expunge the excesses that tend to build towards the tail end of the prior up-cycle." http://www.ft.com/cms/s/0/2eb257ac-ca72-11dc-a960-000077b07658.html

Yeah, right. But what you still have to explain is how the continual expansion of credit volumes can durably (lastingly, or permanently) combine with price deflation. If this is not feasible in the long term, then, if the private and public sector are in reality forced to continue to expand credit volumes anyhow (credit squeeze or no credit squeeze), in the end price deflation must give way to price inflation. And that in turn means that the so-called NAIRU will shift upwards - in a open market, price deflation and price inflation cannot durably co-exist at the same time.


ope mailing list

This archive was generated by hypermail 2.1.5 : Mon Mar 31 2008 - 00:00:15 EDT