ABC: “Economics is too important to be left to economists”

Perhaps I’m thin-skinned, but when the Archbishop of Canterbury says “economics is too important to be left to economists” my initial reaction is to take it as an attack on my profession. I hope, however, he shares my view that theology is too important to be left to theologians — by which I mean to imply also that he shares my view that every profession should be open to criticism, growth, and insight from nonprofessionals. For the common good. (Tangentially, economics comes from Greek for “management of the household.” It is about good stewardship of society’s resources, not about how to line ones pockets.)

The Times relates Dr. Williams recent appearance on BBC2’s Newsnight program:

Asked if the City was returning to business as usual he said: “I worry. I feel that’s precisely what I call the ‘lack of closure’ coming home to roost. It’s a failure to name what was wrong. To name that, what I called last year ‘idolatry’, that projecting of reality and substance onto things that don’t have them.”

Read it all. The video is here.

As the archbishop was lecturing The City, across the pond President Obama was lecturing Wall Street:

“It is neither right nor responsible after you’ve recovered with the help of your government to shirk your obligation to the goal of wider recovery, a more stable system and a more broadly-shared prosperity,” Mr Obama said.

Mr Obama told the financial sector, which is lobbying aggressively against some aspects of the reforms and hopes to kill a proposed new consumer products regulatory agency, to “embrace serious financial reform, not fight it”.

Administration officials are concerned the political window for significant reform may soon close as the sense of impending disaster fades and normality returns to the system. “The old ways that led to this crisis cannot stand,” he said.

“And to the extent that some have so readily returned to them underscores the need for change and change now. History cannot be allowed to repeat itself.”

The president is absolutely correct. Large institutions are going back to business as usual, taking gambles that risk the stability of the economy, risks that they would not take if their investors did not believe the government would once again be forced to bail out large banks if the alternative was widespread harm to faultless victims.

Indeed, financial sector is even more concentrated with a few large players than it was a year ago. As the Washington Post observed in August,

Today, even with the memory of the crisis fresh in their minds, creditors are granting big institutions more favorable treatment because they know the government is backing them, FDIC officials said.

Large banks with more than $100 billion in assets are borrowing at interest rates 0.34 percentage points lower than the rest of the industry. Back in 2007, that advantage was only 0.08 percentage points, according to the FDIC. Such differences can cause huge variance in borrowing costs given the massive amount of money that flows through banks.

Some form of regulation limiting the size of institutions is required:

If the government continues to back big firms over small, regulators worry that reckless behavior could return to Wall Street.

The administration’s regulatory reform plan takes aim at this problem by penalizing banks for being big. It would require large institutions to hold more capital and pay higher regulatory fees, as well as allow the government to liquidate them in an orderly way if they begin to fail. The plan also seeks to bolster nontraditional channels of finance to create competition for large banks.

The too-big-to-fail problem has been known by economists for some time, but it is only now being taken seriously as a problem for which a solution must be found. Otherwise the financial market will once again follow the incentives presented it by the fact that the government would once again be forced to bail out large banks if the alternative was widespread harm to faultless victims.

As to large salaries for financial wizards, the view of economists (aided by hindsight) is they were high because of the rewards for taking gambles where the government is going to step in and take the downside if the gamble does not pay off. The sick joke amongst economists is how much human capital has gone into socially destructive activity because of these incentives. But also consider what happens when financial markets freeze up as they did a year ago. Financial wizards are necessary for a vibrant economy, we just don’t want to give them adverse incentives.

Added: Did the structure of banker pay cause the crisis? There’s more here.

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