Sebastian Mallaby Interview

with Greg Ip of the WSJ.

The way that Greenspan protected and established the independence, authority and prestige of the central bank was by being more political than the politicians who criticized him. If they wanted to leak bad stories about him, he would leak three bad stories about them. If they wanted to try and entrap him in politics, you know what? He had contacts in the Senate. He would go over there and so and so, who was his enemy, suddenly would not get confirmed to a big administration position. So he knew the dark arts of politics better even than the politicians did.

…This model of the empowered expert, the political guru, is now in retreat in the era of Donald Trump, but it isn’t totally gone. I would say that’s the central legacy that Alan Greenspan has left to the United States.

Read the whole interview.

Greenspan and Financial Regulation

In his new biography of Alan Greenspan, Sebastian Mallaby says some things I agree with, but he also rides a number of hobby horses that I take issue with.

Where I agree:

1. I agree that it is hard to achieve financial soundness through regulation. Financial markets are too flexible and adaptive to prevent institutions from gaming the system. If you want to see that point made at greater length, read my essay The Chess Game of Financial Regulation.

2. From 1970 to 1990, we got rid of interest rate ceilings on deposits, restrictions on bank branches, and futile attempts to distinguish commercial banking from investment banking. The process was long and grueling, with lobbyists engaged in furious rent-seeking battles all along the way. What Mallaby points out, and that I hadn’t considered, is that when the dust settled, we had a more rational, integrated competitive financial sector, but we had the same archaic, fragmented regulatory structure. So we had a separate regulator for thrifts, even though institutions with thrift charters were doing things that the thrift regulator had never seen before. The same with commercial banks, insurance companies, and investment banks. It was a regulatory structure that was set up to fail.

Where I disagree:

1. Mallaby buys into the theory that Brooksley Born should have gotten her way and had all derivatives trading moved to exchanges. I disagree. It is possible to trade derivative contracts in Treasury bonds and bills on exchanges, because the underlying securities are generic and liquid. Traders can benchmark prices and cheaply engage in arbitrage transactions. What AIG and others were doing involved creating a separate credit default swap for each security. In effect, Born would have been asking the exchanges to set up hundreds of different markets, most of which would have been illiquid in terms of the underlying securities.

If Greenspan was reluctant to wade in with financial regulatory proposals, that may have been because he thought that the issues were over his head. In fact, that may be what I most respect about Greenspan. Regulators generally do not see their own limitations. Brooksley Born would be a prime example of a regulator willing to take on a task while lacking sufficient knowledge.

2. Although I agree with Mallaby on the challenges of reining in financial excesses using regulation, he takes the view that monetary policy can and should be used to prick bubbles. He writes as if a major lesson, perhaps even the main lesson, of the financial crisis is that central banks should raise interest rates to pop bubbles. He writes as if this is obvious, when in fact very few economists see it that way, even now. In fact, Timothy Taylor recently pointed to an IMF study saying that global debt is at an all-time high, and only on the extreme right are there economists suggesting that monetary policy needs to be tightened. The other day, I got to attend a talk by Mallaby and I posed this issue. He agreed that his views were not widely shared by the mainstream (the people who complain about low interest rates as a threat to financial stability tend to be on the far right), but he said that one of the perks of writing the book was putting his opinions out there. Fair enough.

3. Mallaby blames the crisis in part on inflation targeting. He sees this policy as the mindless result of Fed officials’ not-entirely-rational preference for low, stable inflation. He could have pointed out that it was the overwhelming consensus of academic economists of the 1980s and 1990s that low, stable inflation was exactly the right objective for monetary policy. They believed that demand-driven recessions were the result of the public’s errors in expectations about inflation. Get rid of those errors by stabilizing inflation, so the thinking went, and you would eliminate recessions. This was known as the so-called Divine Coincidence, because it meant that the Fed could just focus on keeping the rate of inflation steady and let full employment take care of itself.

4. Mallaby takes a cheap shot at the Basel II approach to risk-based capital requirements, in which regulators were to use a bank’s model of its risks to gauge the amount of capital it should have. He compares this to giving a teenager the keys to the Mercedes. (a) I think that Greenspan had retired before Basel II was widely implemented. Most banks, perhaps even all banks, were still on Basel I, which used risk buckets. (b) Rather than being silly, using models was a good idea. The Basel I approach treated a bank that hedged its risks and a bank that went unhedged as identical. Basel I had no coherent way of dealing with derivatives or securities with embedded options, such as mortgage-backed securities. You need to use a model to solve both of those problems. And because every bank codes its portfolio differently, it is impractical to try to input the data into any model other than the one that the bank itself uses. Since you cannot try other models on the data, the best you can do is audit the way the bank goes about its modeling process.

It’s not a perfect way to regulate, but there is no obviously better way. At his talk, Mallaby emphasized that he did not think that any regulatory policy could truly rein in risk-taking. This gets back to point 1 under “Where I agree.”

The Man Who Networked

I just finished Sebastian Mallaby’s The Man Who Knew, his new biography of Alan Greenspan. A few thoughts:

1. It is masterfully written. I have already recommended it to friends who are not economists. I cannot praise highly enough the book’s organization, prose, and editing. Mallaby is a gifted storyteller.

2. One central theme is Greenspan as a brilliant thinker who overcame shyness to ascend to the apex of the Washington social and political ladder. However, I finished the book wondering if the story could be told the other way around: Greenspan as a savvy social networker who exploited his connections to create the illusion that he was a brilliant thinker. As you read the book, keep my interpretation in mind and see how it does or does not fit.

Note that Greenspan’s primary occupation was that of a Wall Street economic soothsayer, a game not known for being rich in intellectual competition. Moreover, as of 1987 Greenspan was not even in the top tier of those (above him would have been Ed Yardeni, Henry Kaufman, and Steve Roach, just off the top of my head).

3. Another central theme concerns the issue of whether Greenspan was a libertarian or a compromiser. Again, I think this may be the wrong framing. I get the sense that he navigated issues piecemeal rather than by following an intellectual framework. If Greenspan often strayed from Ayn Rand’s philosophy, that may have been because his mind was just not given to systematic thinking of any sort.

I’m Now in Cass Sunstein’s Corner

He writes,

If you think that Barack Obama has been a terrific president (as I do) and that Hillary Clinton would be an excellent successor (as I also do), then you might want to consider the following books, to help you to understand why so many of your fellow citizens disagree with you

I could pick a nit and say that these books only explain why a few fellow citizens disagree with the left. But they are a good selection of conservative intellectual thought. I give Sunstein a lot of credit for reading them and recommending them.

One of my biggest worries is intellectual and moral arrogance among policy makers. I think that this contributed to such disasters as Vietnam, Syria, and the housing and regulatory policies that contributed to the financial crisis.

I think that left-leaning lawyers can be particularly arrogant, and I worry about who Mrs. Clinton will appoint to the Supreme Court. If she were to appoint Sunstein, I would now be less worried. I was not such a big fan of Sunstein’s before, but the linked essay fulfills the motto of this blog.

So, let me attempt a similar exercise. What are some books that I would recommend to people who tend to agree with me about things in order to open your minds to other reasonable points of view?

1. In the area of education, I am a proponent of the Null Hypothesis (interventions do not make reliable, replicable, long-term differences). Two books that make a good case otherwise are Goldin and Katz, The Race Between Education and Technology and Elizabeth Green, Building a Better Teacher.

2. People who tend to agree with me on things often like the model of humans as rationally pursuing their interests. Daniel Kahneman’s Thinking Fast and Slow is a must-read for understanding the contrary point of view. You are bound to object to parts of it, but there is much valuable insight in this book.

3. People who tend to agree with me on things often like to emphasize what incentives can explain. However, Joseph Henrich’s The Secret of Our Success is a good reminder that there are other social norms in the background that are important. Another book on the importance of culture is Peter Turchin’s War, Peace, and War.

4. As you know, I am no fan of Keynesian economics or of macroeconomics in general. But I can recommend L. Randall Wray’s Why Minsky Matters and George Akerlof and Robert Shiller, Animal Spirits (although I detested their subsequent book). Scott Sumner’s history of the Great Depression, The Midas Paradox [link fixed], is a tour de force.

5. In Our Kids, Robert Putnam coined the phrase “bifurcated family patterns.” Isabel Sawhill’s Generation Unbound looks at the same phenomenon. Both authors are left of center, so many of you will not find their books congenial, but you can still appreciate the data and the observations.

The Elite Thinks the Peasants are Revolting

Jeff Guo writes,

On a wide range of issues, bureaucrats believe that Americans are ignorant. For instance, over half of them say that the public knows little to nothing about government crime programs, child care programs or environmental programs.

He cites a new book that sounds interesting. A couple of my thoughts (not having read the book).

1. I do not think that the problem is so much that the civil servants under-estimate the knowledge and competence of citizens. I think that the problem is that civil servants over-estimate their own knowledge and competence.

2. In a specialized world, it is dangerous to look down on people just because they do not know your own specialty. Of course a typical citizen does not know what a government agency does. But I would argue that a typical government bureaucrat would need a lot of training to work in a modern farm or factory.

3. It is almost as if the bureaucrats are thinking, “Citizens, you are ignorant about the specifics of what we do to run your lives. That ignorance is proof that you are not competent to run your own lives. Therefore, we should have even more power to run your lives.”

Scott Alexander on The Revolt of the Public

He wrote,

Systems are hard. Institutions are hard. If your goal is to replace the current systems with better ones, then destroying the current system is 1% of the work, and building the better ones is 99% of it. Throughout history, dozens of movements have doomed entire civilizations by focusing on the “destroying the current system” step and expecting the “build a better one” step to happen on its own. That never works. The best parts of conservativism are the ones that guard this insight and shout it at a world too prone to taking shortcuts.

Thanks to a commenter for recommending the post. Martin Gurri’s fear in The Revolt of the Public is that exactly the form of nihilism that Alexander fears is what the Internet facilitates.

Here is a thought: If you could push a button that would destroy everyone’s faith in government, in order that they would become receptive to libertarianism, would you do it?

Maybe the question is too ill-specified. But my answer would be “no,” and in that sense I am conservative. I certainly would like to see people change the way that they think about government, so that they wish it to take on more less responsibilities and face fewer more constraints, but I do not want to blow things up so that we can start over.

My view on Clinton vs. Trump has been different. I see Trump’s authoritarian tendencies as almost certain to be restrained by the media, by left-wing elites, and by important elements of the Republican establishment. Even if we grant that Clinton is cautious, how would she react to, say, a government debt crisis or continued escalation of he costs of Obamacare? My guess is that her response would be authoritarian, with more regulation and controls. And there would be no effective institutional opposition.

However, it is not an easy call. I agree that a Trump victory would probably harm conservatism and libertarianism more than a Trump defeat. And that is worth taking into consideration.

My Review of Erwin Dekker

is now available. I write,

he identifies a number of tensions in their thought: the economist as detached observer versus the economist as political participant; progress versus decline; liberty versus restraint; individualism versus culture; modernity versus tradition; and what Jacob T. Levy would call rationalist versus pluralist.

The book, The Viennese Students of Civilization, is published by Cambridge University Press, about which I have several complaints.

1. After several tries, I still have not found it on their web site. Here it is on Amazon.

2. The price is terribly high, particularly for the Kindle version.

3. To add insult to injury, it appears to me that CUP did not spend a dime (or should I say a pence?) on editorial assistance. The book is filled with errors of English usage.

It is an important book, and shame on CUP for making it hard to afford and difficult to read.

What I’m Reading

State Capitalism, by Joshua Kurlantzick. His theme is that many developing countries have the government own and manage large companies in important industries. However, they use prices rather than commands.

I had not been aware of how prevalent this practice has become. My reaction is that it is a viable model as long as those industries are not disrupted.

Influences on One’s Thinking

Sam Bowman of the Adam Smith Institute says who influenced him, including

How Richard Dawkins Got Pwned and An Open Letter to Open-Minded Progressives — Mencius Moldbug (Both very long.) I am not a neo-reactionary, but sometimes I think Mencius Moldbug is the greatest living political thinker. His claim that progressivism is a non-theistic sect of Protestantism, with all of Protestantism’s evangelism and intolerance of heresy, is in particular very persuasive to me. I also think ‘neocameralism’ is quite a cool model for a state and I’d like to see it tried out somewhere.

Pointer from Tyler Cowen.

Most of Bowman’s influences come from the right, but a few come from the left. I notice that all of those on the left have prestigious academic positions. Many on the right do not. I do not think that is purely coincidental. I believe that if you limit your reading to credentialed academics, you will miss many important thinkers on the right, but you won’t miss out on much from the left.

I always like to play this sort of game myself. In chronological order, some of my influences: Continue reading

A Searle Thought to Ponder

In Making the Social World, John R. Searle writes,

If we assume that democracies are defined in part by majority rule as expressed in elections, then another feature of successful stable democracies is that few, if any, of the important problems of life are determined by elections. Such questions as who will live and who will die, who will be rich and who will be poor, cannot be decided by elections if the country is to be stable. Why not? Elections are too unpredictable for people to be able to plan and live their lives based on the outcome of elections. If you knew that if your opponents won the next election, you were likely to be thrown into a concentration camp, or executed, or have all your property confiscated, you could not make stable and enduring life plans. In successful democracies, it does not matter who gets elected. . .I have noticed that life pretty much goes on after the election as it did before, regardless of who gets elected.

Some thoughts.

1. It is of course in the interest of political activists and journalists to argue otherwise–that “this is the most important election in history,” that the wrong choice will lead to disaster, etc. Their warnings typically do not turn out to be valid, although some day that could change.

2. This is an argument for keeping the stakes in politics low, and thus the argument tends to weigh in on the libertarian side of things. However, I doubt that those who favor activist government will think much of the point that “elections are too unpredictable.”