Yesterday, on this site, a book entitled “Ethics and Economics ,” authored by Mr. Wight,was discussed. The review raised a few points that were a bit unclear to me.
One of the points made was that the government lacks knowledge about society. This is a bit surprising since the Bureau of Labor Statistics, the Commerce Department, and the Board of Governors at the Federal Reserve are probably the largest suppliers of raw economic data in the United States. If, as a review of the book states, legislators often act in a manner contrary to the public interest, perhaps a review of the Supreme Court’s recent Citizens United Case, which allows for virtually unlimited campaign contributions should be in the cards.
Like most conservative analysis, Mr. Wight ignores the basic concept of externalities. When the state improves the highway system, this helps all by providing economic growth via ease of transportation. When an entity pollutes, passing on the cost of cleanup to the wider society, this is a negative externality. A purely market-driven economic policy will not provide positive for the wider society.
An examination of the 2008-2009 financial crisis demonstrates the folly of totally unregulated markets. The institution at the core of the debacle was the insurance giant A.I.G. and its subsidiary A.I.G. Financial Products.
A.I.G.F.P. was the largest player in the credit default swap market. Credit Default Swaps are insurance written to guarantee the principle of a bond. A yearly premium is a percentage of the interest paid on the bond. A.I.G.F.P. was a leader in insuring mortgage-backed securities. This market was totally unregulated and unlike most insurance products and derivatives written against currencies or S&P movements, no reserves were required. The A.I.G.F.P. was in effect renting the rating of the parent company to issue unreserved for insurance.
A.I.G.F.P. was closely monitored by then-C.E.O. Hank Greenberg until he was forced out in an accounting scandal brought on by Elliott Spitzer then Attorney General of New York. The charges were later dropped but without Greenberg’s oversight, A.I.G.F.P. ramped-up its business, and in the short run was a significant contributor to the company’s overall products.
When the housing market burst, payments were required to fund the credit default swaps written against defaulted mortgages. Because no reserves had been required, and there was no regulatory oversight for that market, the Federal Reserve Bank of New York was forced to bail-out the company to the tune of about US$180 billion. Had the activities of A.I.G.F.P. been monitored in thee way Futures Exchanges and traditional insurance companies, the Great Recession and the recovery would have been less severe and costly.
Sometimes, the Government should play a role.
— Les Schreiber