Low Level of Economic Literacy is Plaguing Financial Reform; Time for Grownups To Step In

"From the perspective of economic literacy, last week’s hearings before the Senate’s Permanent Subcommittee on Investigations exposed an unnerving ignorance of fundamental principles of market economics by folks who have a hand in remapping rules of finance that will be with us for a while. Flip assertions about what is and is not socially valuable reflect a confusion about our market economy that is as fundamental as knowing that George Washington was the first president of the United States. Maybe it’s human nature to get self righteous about the mistakes others make when there are even worse problems in our own back yard that we should be tending to.

The low level of economic literacy is plaguing financial reform. Reform is dangerous—it produces unintended consequences—if we don’t understand the connection between incentives and economic behavior. Folks may like to hear that someone else is to blame for the mistakes they made, but everyone knows—including those who bought houses far beyond what they could afford and then walked when the promise of endless capital gains died and including the investors who bought funky financial instruments that enabled the housing bubble out west and in Florida to inflate—that Wall Street isn’t the only culprit in the housing debacle.

Goldman was no more culpable in the housing debacle than Congress. Because Washington is mostly focused on appeasing political outrage, the financial reform legislation in its present form seems likely to do little to fix the flaws and is heavily focused on changing things that had little to do with the housing debacle.

What flaws need fixing? The financial system is highly interconnected. The bankruptcy laws need to be modified to allow for an orderly unwinding of a failing financial institution (for example, ending the exemption given derivatives has attracted some attention). No institution should be too big to fail. Public funds should not be relied on to resolve failing financial institutions.

Now that the financial reform debate is in the final innings, it’s time for the grownups to step in. In its present form, financial reform will make credit more expensive and more difficult to obtain and businesses will find it more difficult to shed risk, harming the very people we are trying to help. Done right, reform will increase transparency, allow failing institutions to fail, and not stand in the way of financial innovation that has allowed those who want to shed risk to pass it to those who seek it, an evolution that has contributed to the US economy’s robust performance in the past."

~Jim Glassman, senior economist at JPMorgan Chase

HT: Pete Friedlander