Saturday, April 4, 2009

Tyler Cowen Is Very Wrong

Tyler Cowen has a truly bizarre column in this morning's New York Times. He argues that there's "a big hole" in the Obama administration's proposals to reform financial regulation: "the new proposals immunize the creditors and counterparties of [firms like AIG] by protecting them from their own lending and trading mistakes." He goes on at length about how the administration's proposals "neutraliz[e] creditors," and thus risk "creating a class of institutions whose borrowing is, in effect, guaranteed by the government." This is 100% untrue. The Treasury's proposals specifically included a proposed resolution authority for systematically significant finanancial companies like AIG, modelled on the FDIC's resolution authority. And like the FDIC's resolution authority for insured banks and thrifts, the Treasury's proposal gives the FDIC the power to impose pain on creditors—which is exactly what Cowen criticizes the Obama administration for failing to propose! Specifically, the FDIC would have its traditional powers of avoidance, as well as the power to repudiate "burdensome" contracts. This undercuts Cowen's entire column. I honestly don't know how he could have missed this—the proposed resolution authority was the most talked about aspect of Treasury's proposed financial regulations. What's even more amazing is that the NYT's editors let Cowen's column go to press. I guess they don't read their own paper.


septizoniom2 said...

i think his point in the article is more about the failure to explain to the public why creditors have not to date been allowed to suffer any pain after lehman and that this endangers political will going forward to deal with the crisis.

Anonymous said...

I agree that he should have addressed the Treasury proposal, but I think the key to the argument is that he agrees with this statement of yours: "This same critique applies to Simon Johnson's absurdly unrealistic suggestion that the Treasury could use its proposed resolution authority for large financial institutions to deal with the current financial crisis."

The key to his argument is at the end: "This poses a very difficult public relations problem for the government, because the Federal Reserve and the Treasury do not want to discuss the importance of the creditors too publicly right now.

Why not? It would be bad precedent, and mind-bogglingly expensive, to promise to pick up all future obligations to major creditors. At the same time, any remarks that threaten to leave creditors hanging could panic the markets. So silence reigns, the Fed and Mr. Geithner receive bad publicity over the bailouts, and we are all laying the groundwork for a future financial crisis."

In other words, you may be confident that the upcoming regulation will be effective, but he is concerned that "that the next regulatory regime could end up even worse than the last."

I, like Cowen, do not share your optimism.

Economics of Contempt said...

septizoniom2: That strikes me as an extremely charitable interpretation. While Cowen did mention that the bailouts haven't forced creditors to take losses, the entire column was very forward-looking, and he specifically criticized the administration's regulatory proposals for allegedly "neutralizing creditors" several times.

Anon: I never said I was optimistic about Treasury's proposed resolution authority -- I'm actually extremely pessimistic about it. Frankly, I don't think it will ever work. That is, I don't think a complex financial institution like Citi, JP Morgan, or even AIG can be put into FDIC receivership/conservatorship without causing an international financial crisis. And forget about a P&A agreement -- if we're at the point where Citi or JP Morgan are failing, who is going to be in a position to buy them on short notice? No one.

Anonymous said...

Your position is remarkably incoherent. I think you would agree that we currently have Too Big to Fail (TBtF) financial institutions.

The question Cowen is trying to address is: What do we do about them? As far as I can tell there are two extreme options with a range of in-between possibilities. The extreme options are: Let market forces work by putting the firms through bankruptcy (the Lehman method) and bail them out now but count on heavy regulation to prevent future crises.

Because Cowen has a constitutional distrust of regulators' competence, he believes that we need to marshall market forces to prevent future crises. This is an intellectually coherent position.

You on the other hand claim to distrust the regulatory solution, but think the market solution is also stupid. Are you arguing that we should spend the rest of time careening from one financial crisis to the next? I don't get it.

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