Monday, March 9, 2009

The political economy of financial structure

Perhaps the financial situation - e.g., in and around derivatives - really is too complex for anyone to understand, unless they have the inside knowledge of regulators. This would mean, of course, that going forward no one can question Treasury about anything important.

But that, in turn, makes congressional oversight impossible - even if we move to closed door hearings. And it raises the question: if our financial system has become so economically complex that President Obama is right, then is it also too complex to be politically sustainable?

Big financial players now know they have a colossal potential put or bailout option. They can also construct interconnected structures that no one can understand, except possibly the Treasury. So every 10-20 years (or more often?) we will experience a crisis of current proportions? ...

Derivatives have the potential to create a rent-seeking structure that is unparalleled in human history. No society can afford to allow that kind of financial system to operate. Either we figure out how to make it much more transparent - and amenable to outside review - or the re-regulation process currently in the hands of Senator Dodd and Congressman Frank needs to consider more radical alternatives.
--Simon Johnson, Baseline Scenario, on too complex to be permissible

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