Tuesday, 19 May 2009

Hoicked from the comments

In a comment on the non-classical cost benefit analysis post of a few days ago (a title, I think you will agree, of gigantic pretention), Dave said:
I agree with your conclusions: that uncertainty and moral hazard can make CBA unreliable and sometimes it is better to rely on qualitative objectives.

But I disagree with your applying these to systemic risk. Firstly, with systemic risk it is the "worst-case scenario" that is important. If regulators had used the great depression as the worst case scenario, they wouldn't have been far wrong.
Often, though, the worst case scenario can be hard to identify. The worst case scenario in much of finance for instance is that all claims are worthless and all liabilities come due immediately. We might as well all go home if that comes true, and barricade the doors. 'Plausible' worst cases have a nasty habit of turning out to be too optimistic: wasn't it David Viniar from Goldman who said that 2008 was much worse than the most pessimistic scenario they looked at?
Secondly, I can't see how systemic risk regulation would cause bankers to take greater risks. So, I don't see where moral hazard fits in.
Fair enough - bankers are not people riding bikes. (Quite literally, usually - Wall Street tends to view cycling to work as only marginally less strange than coming by elephant.) So probably bankers did not take more risk because they were regulated. Some of them did, however, take as much as they could subject to regulation, because that was the way to maximise returns to shareholders.
Thirdly, how do you take a "moral" position on systemic risk? I don't think this gets you very far.
Well, I think that the key idea of Anglo-Saxon capitalism - that the first and only duty of a firm is to its shareholders - is simply immoral. Of course, like any ethical judgement, you can disagree with that. But I also think, and I'd like to think that I can prove, that a system that has a wider burden of responsibilities, including a responsibility to the financial system, would be less likely to go into crisis, cost the taxpayer less over the cycle, and deliver slower but less volatile growth.
Finally, the main impact of systemic risk regulation would be to encourage smaller banking/trading institutions. I would think that this a good thing in itself. And I disagree with James Kwak that "countercylical measures in a boom dampen economic growth". Surely the opposite is true (in the long run).
Absolutely. We need a lot of small banks, not a small number of large ones. The hard part is how we get to there from here.

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Blogger Dave said...

Thanks for your response. I agree with you that "worst case" is pretty nebulous.

You comment that "the idea that the first and only duty of a firm is to its shareholders is simply immoral". A "firm" is a legal "person" but not a real person, so it cannot have moral obligations.

Perhaps you mean "the idea that the first and only duty of management is to its shareholders is immoral". But how can that be? The managers are the shareholders agents, so surely this is where there duty lies.

Or perhaps you mean "the idea that the first and only duty of shareholders is to maximise profit is immoral". Well, that's true if you take the utilitarian position that it is everybody's happiness that counts, not just your own. But that is a strict morality that few of us can live up to.

In any case, capitalism does not require profit maximisation. If enough "ethical" shareholders want to run a company on non-profit lines they can do so. Capitalism allows this.

Or perhaps you mean "the idea that the first and only duty of management is to maximise their own rewards is immoral". I think this is closer to the truth. As a manager - irrespective of your financial incentives - you have a moral responsibility to your shareholders, even if this is at the cost of your own reward.

It is in this context that I think much recent behaviour has been "immoral" and has created many of the problems - and systemic risk - in the financial sector.

12:30 am  
Blogger David Murphy said...

Thanks for the comment Dave.

I guess it depends what you mean by 'moral'. But yes, I was thinking of a naive utilitarianism where 'moral' means the thing that leads to the 'the greatest good for the greatest number', whereas 'immoral' is something that leads to an outcome significantly different from that. (This is philosophically problematic in many ways - see for instance Rawls - but let's run with it.)

What I mean by 'the key idea of Anglo-Saxon capitalism - that the first and only duty of a firm is to its shareholders - is simply immoral' in this light is 'the key idea of capitalism leads to less good outcomes than a broader stakeholder model of corporate responsibility'. Of course one cannot blame managers, still less corporations for this: it is more a comment on outcomes that come from a particular legal choice about what a corporation is.

Personally I think that we have a huge opportunity to revise the rules, an opportunity we are in grave danger of missing and which will not come back for a generation or more. That means that it is really worth asking the question 'what idea of corporation leads to good outcomes for society'? People will disagree about is or is not a good outcome, but at least by focussing attention on the consequences of a given set of rules, we can debate what if anything needs to be done.

10:07 am  

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