If I were in charge of designing financial regulation, rather than try to make the financial system hard to break, I would try to make it easy to fix. I sketched this out thirteen years ago.
But my approach would give less power to bureaucrats to channel credit and to see themselves as heroes who rescue the financial system from crises that those bureaucrats helped to create.
The economist Allan Meltzer liked to say that “capitalism without failure is like religion without sin. It doesn’t work.” After the 2008 financial crisis, Meltzer worried that bank bailouts were undermining public support for capitalism. He feared that politicians would steer the financial system toward more government regulation and away from the natural regulatory power of market competition. More Americans would begin to believe that only the state could protect them from the instability that comes with economic freedom.
Sure enough, in 2010 Congress passed the Dodd-Frank Act, which promised “to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail,’ to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.”
Mr. Hoenig calls the latest events “inevitable” given Dodd-Frank’s regulatory framework. He places much of the blame on the Fed’s use of “risk-weighted capital” to judge a bank’s health. This measure doesn’t account for “duration risk,” which got SVB into trouble. Long-term debt is sensitive to changes in interest rates. As rates rise, even safe assets like Treasury bonds decline in price, so that liquidating them entails large losses.
SVB “had billions of dollars of assets that were rated risk-free or low-risk from a credit perspective, but they were not duration-risk-free,” Mr. Hoenig says. “SVB’s ‘risk-weighted capital’ focused almost exclusively on credit risk. Meanwhile, duration risk was screaming danger.”
The original sin is monetary policy, Mr. Hoenig says. When he was a voting member of the Fed’s Open Market Committee in 2010, he was often a lonely dissenter. While most of his colleagues cheered near-zero rates for years, he argued for gradually returning the price of credit to something normal. By not normalizing rates, the Fed was fueling ever-greater risk-taking in search of yield. Now, in an effort to control inflation, the Fed has raised the fed-funds rate by 450 basis points over the past year, exposing this policy error.
In reflecting on how we got the current panic, Mr. Hoenig sounds like Allan Meltzer. “One of the worst things I think that’s happened, and I’ve watched,” he says, is that “market discipline has atrophied. There is none.” Regulators keep insisting that the banks are “very, very sound.” He allows that bank capital is “certainly better than in 2008.” But “better isn’t adequate,” as we’ve again learned the hard way this week.
There are few more successful examples in history of the propaganda technique known as the “big lie” than the charge that Herbert Hoover was a “do nothing” president. In fact, Hoover was being perfectly truthful when, in the course of the ’32 campaign, he said. “We might have done nothing. … Instead, we met the situation with … the most gigantic programs of economic defense and counterattack ever evolved in the history of the Republic.” So, for that matter, was his opponent, who accused the Hoover administration “of being the greatest spending administration in all our history” (Lyons 1948, 287). On public works alone, the Hoover administration spent more than the previous nine administrations combined, notwithstanding that their undertakings included the Panama Canal (ibid., 269). No previous administration, David Kennedy (1999, p. 48) observes, ever “moved so purposefully and so creatively in the face of an economic downturn.”
Dan Hannan makes the case against retaliatory trade restrictions. (HT Iain Murray)
While epidemiological investigations are clearly important and valuable, they have their dangers, as perhaps the response to the COVID-19 pandemic demonstrates. During this pandemic, the distinction that Frederic Bastiat so brilliantly pointed out in the 1840s, between the seen and the unseen, was lost sight of: and the fact that locking down whole societies to prevent an illness from spreading to people in whom it would do little harm might have very serious consequences was ignored by many epidemiologists. They were like people who would halt all traffic because traffic results in accidents.
Humans understood natural immunity hundreds of years before believing Earth revolved around the sun. And yet the US government censored American citizens who pointed to the scientific studies proving natural immunity also worked against Covid.
It’s their sheer smallness that is so striking. Their banality. Their triteness. I had hoped, reading The Lockdown Files, to find some explanation for the miseries that were inflicted on us in 2020. Perhaps decisions that looked imbecilic to the rest of us might make sense to those in the control room, able to survey information that we could not see. Perhaps there was a grand plan.
But not a bit of it. What we see in the leaked WhatsApp messages are petty, frightened men at the mercy of events. They obsess over tweets and news reports. They fret about how they are coming across.
Again and again, decisions are made for presentational rather than medical reasons. Quarantine could safely be cut from 14 to five days; but the problem, says Matt Hancock, is that this would “imply we’ve been getting it wrong”. “Imply”?
What we see is not a bad man, but a well-intentioned man caught up in a machine that might have been deliberately programmed to generate bad outcomes. Britain was driven into abandoning its proportionate, cool-headed epidemic plan, not just by shrieking TV presenters, but by perverse incentives. Put simply, decision-makers knew that they would not get into trouble for excessive caution. They could blow away billions, bankrupt businesses, ruin children’s education, and none of it would be a resigning matter. But make the slightest mistake the other way, and they would be done for.
Easy to say in hindsight? Maybe. But those of us who said it at the time were roundly denounced as granny murderers. In February 2020, I recalled the ridiculous forecasts that had accompanied bird flu and swine flu, and cautioned against panic: “Politicians, like most people, are bad at calculating risk, and almost every minister would rather be accused of over-reacting to a threat than of having done too little. There is a similar bias, albeit a less pronounced one, among the various medical advisory bodies”.
Why, then, were we panicked? What happened to the original epidemic plan, which was to allow infections to seep gradually through the population so that hospitals would not be overwhelmed at any one moment?
The answer can be glimpsed in a message on March 8 from James Slack, Boris Johnson’s calm and measured spokesman: “I think we’re heading towards general pressure over why our measures are relatively light touch compared to other countries.”
Too bloody right. And the pressure – cretinous rants from Piers Morgan, false rumours of hospitals being overrun, “Go Home Covidiots” signs – grew until, two weeks later, a prime minister who hated nannying with every bone in his body felt obliged to sentence the population to house arrest.
Could he have resisted that pressure? Other countries had already closed, 92 per cent of the electorate wanted to be confined and the scientific advisers, sniffing the wind, had switched to arguing for tougher measures.
But one country held out. Sweden, lacking its own pandemic plan, had adopted Britain’s – and, unlike Britain, it did not crack under criticism. Sweden is our counterfactual, a laboratory quality control showing what would have happened here had we held our nerve. And the evidence it presents looks damning. A study has found that, from 2020 to 2022, Sweden had the lowest excess mortality rate in Europe.
During the pandemic, I assumed that Sweden would emerge with a slightly higher death rate, but a much stronger economy. Since poverty correlates with lower longevity, I expected that, over time, Sweden would see fewer deaths from other causes, so ending up healthier as well as wealthier. But I underestimated the lethal impact of the lockdowns themselves. Sweden did not just do better over time; it actually killed fewer people during the pandemic.