Yves Smith on the Fed’s Possible Stance on the Credit Market

Yves Smith over at Naked Capitalism has been following the sub-prime meltdown. As part of that, today he looks at a speech by Minneapolis Fed President Gary Stern. An excerpt from his post:

Even though regulation entails costs in terms of reduced efficiency and reduced profitability, the scale of the damage argues for incurring those costs. Yet, incredibly, Stern is arguing against meaningful change despite overwhelming evidence of serious problems. How can that be?

I can come up with only three rationales:

1. The debate has gotten away from the Fed and is being driven by Congress. Stern is trying to tell the pols not to stick their noses in matters that are over their pretty little heads. While this is plausible, I don’t see Fed officials taking the steps needed for them to influence the debate around regulatory reform. You can’t expect legislators with very unhappy constituents to do nothing.

2. Stern recognizes that what our financial system is what Richard Bookstaber, in his book Demon of Our Own Design, called a “tightly coupled system,” like a nuclear reactor. In tightly-coupled systems, measures to increase safety can often have the opposite effect.

3. Stern (and likely his Fed colleagues) believe in a lightly regulated system and are unwilling to back the level of intervention and oversight that is needed to effect fundamental change.

Although the rationale for Stern’s posture may be 2, I believe the real reason for his belief is 3. He and his colleagues have grown up in a regime that sees minimal government intervention as virtuous, and find it difficult to consider anything else. While it is an ideological bias, it is so pervasive that many wouldn’t even recognize it as a belief system. It’s simply what is widely held to be good practice.

Go read the rest.