A reminder this weekend, after a week of House Financial Services discussion about creating a new agency to help consumers, that regulators are fallible. John H. Cochrane, University of Chicago economist, wrote a paper last month titled: “How did Paul Krugman get it so Wrong?” in response to the NYT’s economists critique of economics. While Krugman had many good things to say, Cochrane is dead on in this critique:
Well, if markets can’t be trusted to allocate capital, we don’t have to connect too many dots to imagine who Paul has in mind.
To reach this conclusion, you need evidence, experience, or any realistic hope that the alternative will be better. Think of the great job Fannie, Freddie, and Congress did in the mortgage market. Is this system going to regulate Citigroup, guide financial markets to the right price, replace the stock market, and tell our society which new products are worth investment? As David Wessel’s excellent “In Fed We Trust” makes perfectly clear, government regulators failed just as abysmally as private investors and economists to see the storm coming. And not from any lack of smarts.
Regulators are just as human and irrational as market participants. If bankers are, in Krugman’s words, “idiots,” then so must be the typical treasury secretary, fed chairman, and regulatory staff.
Read Cochrane’s whole piece here.