Forty years ago, Friedrich August von Hayek received the Nobel Prize in economic sciences
for his "pioneering work in the theory of money and economic
fluctuations" and for "penetrating analysis of the interdependence of
economic, social and institutional phenomena."Officially
known as the Sveriges Riksbank Prize in Economic Sciences in Memory of
Alfred Nobel, it was first awarded only five years earlier.
In his banquet speech,
Hayek mused that perhaps such an award never should have been created,
lest its recipients think too much of themselves. He told the Nobel
Committee that he was "almost inclined to suggest that you require from
your laureates an oath of humility, a sort of Hippocratic Oath,
never to exceed in public pronouncements the limits of their
competence." Our regulators should take a similar oath, and I nominate
the financial regulators to be the first to take it.
Reshaped
by the Dodd-Frank Act, financial regulation has taken a decidedly
anti-Hayekian turn. The legislative response to the financial crisis
consisted primarily of handing more powers to expert regulators in the
hopes that they would prevent the next crisis. A group of these
regulators, for example, are part of a new regulatory body, the
Financial Stability Oversight Council. The FSOC — informed by the Office
of Financial Research, a new governmental data aggregator — must
"identify gaps in regulation that could pose risks to the financial
stability of the United States."
The FSOC also picks
out financial institutions that "could pose a threat to the financial
stability of the United States" so that the Federal Reserve can watch
over these companies, guide their every move, and try to ensure that
they never fail. If the Fed slips up, the Federal Deposit Insurance
Corp. stands by to design a special rescue plan under Dodd-Frank's
so-called orderly liquidation authority to protect the institution and
its favored creditors.
Viewed through the lens of Hayek's Prize Lecture, entitled "The Pretence of Knowledge," this financial regulatory regime is troubling. In his lecture, Hayek observed that:
The
recognition of the insuperable limits to his knowledge ought indeed to
teach the student of society a lesson of humility which should guard him
against becoming an accomplice in men's fatal striving to control
society — a striving which makes him not only a tyrant over his fellows,
but which may well make him the destroyer of a civilization which no
brain has designed but which has grown from the free efforts of millions
of individuals.
Dodd-Frank's financial stability
regime, however, is built on the belief that a group of regulators can
gather and comprehend enough knowledge to manage our complex financial
system. These regulators are charged with using their allegedly superior
knowledge to override decisions made by countless individuals and firms
in the marketplace. Dodd-Frank is by no means the first statute to
displace market-based decision-making. The pre-crisis financial markets
were shaped by a messy tangle of market and regulatory forces. But
Dodd-Frank allows regulators an even freer hand to substitute their own
thinking for the "free efforts of millions of individuals."
The
FSOC, the OFR, the Fed, and the FDIC employ very well-educated lawyers
and economists, but all that education still leaves them decidedly less
knowledgeable than the markets they regulate. Hayek, in his Nobel
lecture, remarked that "[w]e are only beginning to understand on how
subtle a communication system the functioning of an advanced industrial
society is based — a communications system which we call the market and
which turns out to be a more efficient mechanism for digesting dispersed
information than any that man has deliberately designed." Even after
all these years, we still cannot fully appreciate the market's ability
to collect and process information. Consequently, we must assess any
proposed interference in the market with skepticism.
Defenders
of the new regime speak of bringing financial activities out of the
shadows and into the regulatory light. Allowing regulators a better view
of what is transpiring in the financial markets is fine, but it is more
important for regulators not to stand in the way of market
participants' access to the information, because they are able to act on
it. Regulators are often inclined to keep information from market
participants for fear they will act on it. (Think bank to crisis-era
regulatory commands that healthy banks take TARP money so that the banks
that actually needed it would look as if they were healthy too.)
Especially
after a deep financial crisis, it is tempting to believe that we can
avoid another by giving regulators additional controls over the
financial markets. A more radical — and more effective — approach would
have been to acknowledge regulators' limits and embrace the markets'
superior ability to make the tough live-or-die, expand-or-contract
decisions for financial firms. Doing so would have required eliminating
government guarantees, subsidies, and barriers to entry that interfere with the market's ability to collect, communicate, and act on information.
Four decades after Hayek received the Nobel Prize, there are many corners of the world that have yet to absorb his message of humility.
To change that, financial regulators and their legislative benefactors
should commemorate this two-score anniversary milestone by revisiting
Hayek's pioneering work
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