Should we be concentrating regulatory attention on Systemic Risk?

Think of it somewhat like the town that just suffered a very bad winter season with huge snowfalls that they were unprepared for clogging up everything for weeks on end. They spend the spring fixing up and deciding what to do. Their conclusion is to have all town employees carry snowshovels at all times and to keep snow plow trucks patrolling the streets all day and all night through the entire summer. Sometime in early fall, they decide that was a waste of time and sell all the shovels and trucks by the end of the fall.

RISKVIEWS does not think that our situation will include any systemic risks that we will anticipate. We will not repeat the exact same mistakes. Systemic risk oversight will in the end be a fixed Maginot Line defense.

What we need is

  1. to figure out how to distinguish between creation of wealth by new innovation and by extraction from past innovation so that we can encourage the former and discourage the later. The former widely distributes increases in wealth while the latter concentrates it.  The former creates growth while the latter captures the benefits of future growth now – which means that we will not have them later.
  2. to understand leverage better. Look at the Minsky Financial Instability Model myself. Often, we are not honest with ourselves on the extent of debt. RISKVIEWS favors full disclosure over regulations. For example, firms should disclose the amount of debt that is implicit in derivative positions. And disclose the counterparties for that debt.
  3. to figure out how we are going to find the next big thing that will employ all of the people who are now permanently, structurally unemployed. We can keep hoping for something that increases wealth, something that merely decreases wealth less than the current situation or something that decreases wealth but employs people.
  4. to orient research into how to operate an economy in the long term with much less or no growth. Most of our economic expectations are built off of a constantly growing economy. With population about to start falling, we will necessarily experience much less growth. We don’t collectively even have any idea of what the shift to large retired populations will do to our economies.

The regulators need to focus on whatever is within their purview that gets in the way to accomplishing those things.

For the town above, that means storing the snow shovels to the winter and looking at the problems of the summer heat. They still need to keep an eye out for the next winter. But that does not mean it needs to be a primary focus NOW.

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3 Comments on “Should we be concentrating regulatory attention on Systemic Risk?”

  1. Robert Arvanitis Says:

    Excellent distinction — creating new wealth vs. milking old innovation.

    As to “systemic risk,’ once government gets bigger than 20% of GDP, then government ITSELF is the greatest danger.

    Think of iatrogenic disease in the 19th century. It was the doctors themselves, visiting many sick patients yet unaware of proper sanitation, who spread the most illness.

    In the same way, excessive bureaucratic intrusions inevitably–unavoidably–create problems and misaligned incentives. Too many constraints and too few free variables. Over-determined equations, hence contradictions.

    The hippopotamus gets in the bath tub. The water overflows and soaks everything. The hippo declares an emergency and nationalizes all the towels.

    • riskviews Says:

      What you describe suggests that government becomes the systemic risk. Which is the case in Europe with the sovereign/euro risk. But I am not convinced that regulators can be of any help with that.

      I am also not convinced that anyone knows what the magic number is. Any more than Laffer knew whether we were above or below his magic number for taxes.

      • Robert Arvanitis Says:

        Actually, that’s the point. Regulators ARE the biggest risk today.

        And yes, 20% is an expert opinion, nothing more. But it’s clear that as government grows, a senator becomes a far better “investment” than a factory, say.

        [In support of the the 20% range -- that been the long term tipping point in history; 10% to the king, another 10% of crop withheld for next year's seed. Beyond that, the incentives to keep up the life struggle all fail.]

        The solution is simulation models — games — where we try out alternative strategies. The players include the firm, clients, competitors, suppliers, and politicos AS interested parties themselves, not mere referees.


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