Financial regulation: Truth Vs Precision

In my blogpost Financial paradise I said that the last economic crisis was predicted by Minsky, although nobody listened to his words. He forecasted the accumulation of unsustainable financial positions by market makers, especially bankers.

Ergo, in order for history not to repeat itself, difficult measures must be taken. The incumbent have not paid enough for their mistakes.

Above all, says Wolf, is that we want to keep capitalism on its feet – since it’s the only production system that works despite its many flaws. Unfortunately, the ultra defenders of capitalism (read neoliberals) are victims of wishful thinking when they irresponsibly claim that financial markets are efficient. As incredible as it may seem people like Scott Summer, who aims to have some kind of influence on monetary policy, still defends the theory of the efficiency of markets.

Only from a realistic point of view, taking history into account and the fact that the freer markets have been the bigger crisis we have suffered, may we leave the system in private hands.

Deregulation has been a historic mistake. In that sense I agree with Krugman in his magnificent End This Depression Now!, or with Gary Gorton. Both admit that Minsky was right not to express it mathematically. Minsky, as Keynes, was a good mathematician, yet both had the good taste not to mix math with the economy.

Finance is a bridge connecting the present with the future. It is absolutely necessary. But when it does not respond to the need to invest in human and physical capital,  finance becomes a fake. Any innovation allowing finance to distort and move that risk is the causal core of the crisis.

What next? Martín Wolf offers a synthesis of the most attractive options, ultimately oriented towards defusing the perverse incentives that have produced those gigantic financial mistakes.

“So what is to do be done? Here are a few preliminary answers.

First, morality matters. As Prof Zingales argues, if those who go into finance are encouraged to believe they are entitled to do whatever they can get away with, trust will break down. It is very costly to police markets riddled with conflicts of interest and asymmetric information. By and large, we do not police doctors in this way because we trust them. We need to be able to trust financiers in much the same way.

Second, reduce incentives for excessive finance. The most important incentive by far is the tax deductibility of interest. This should be ended. In the long run, many debt contracts need to be turned into risk-sharing contracts.

Third, get rid of too big to fail and too big to jail. These two go together. The simplest way to get rid of too big to fail would be to substantially raise the equity capital required by global systemically important financial institutions.”

I would add that universities should stop funding all this nonsense of general equilibrium mathematical economics and the efficiency of markets. Mathematics are incompatible with economics, which is the study of human activity of certain characteristics with a level of uncertainty. As soon as you consider the possibility of uncertainty, mathematics get out of the room (no matter how the sympathetic Roger Farmer believes he has mathematized the “Animals Spirits”.)

“Truth versus Precision” should appear on the frontispiece of the best universities of economics. So perhaps eventually, Spanish universities will become inspired and tackle the economy’s real problems.