Roger’s Rules

Scylla and Charybdis, or regulation, risk, and the passion for "fairness"

Today’s two essential articles: 1) Paul Singer’s “Free-Marketeers Should Welcome Some Regulation,” which appeared in The Wall Street Journal and 2) Charles Krauthammer’s “Obama’s Ultimate Agenda,” available in many outlets.

Let’s start with Mr. Singer’s column. I suspect that its title has caused many conservatives to break out in a cold sweat: “Free-Marketeers Should Welcome Some Regulation.” What’s going on here? “Oh no!,” I can hear my conservative friends say say, “What is happening? How could Paul Singer, who not only runs a successful hedge fund but is also chairman of the libertarian-leaning Manhattan Institute, how could he be calling for Regulation?  Is this not a betrayal of free market principles? Et tu, as Shakespeare’s Caesar memorably put it, Brute?”

Calm down. I know that “regulation” is a suspect, even a dirty, word in the conservative’s lexicon. I myself, when ever encountering it, follow the practice George Orwell recommended regarding saints, i.e., I consider it guilty until proven innocent. But Mr. Singer is on to something important and it behooves us, especially those of us who are supporters of the free market, to heed what he has to say. First, the problem:

In the past decade, most global financial institutions built highly leveraged balance sheets — sometimes as high as 30 to 1 — that were stuffed with risky assets. These institutions also bought on a large scale for their own accounts the same securities they sold to their customers. Our anachronistic regulatory framework didn’t catch the problems, and warped incentives and compensation schemes fueled the risk-control failures that eventually brought on the crisis we face today.

The economic implosion we have just witnessed was not caused by the operation of the free market, but rather by a failure to follow certain strictures that allow for the orderly working of the free market, i.e., an adequate recognition and pricing of risk. As. Mr Singer observes,

[W]e must create a new regulatory infrastructure that will meet three fundamental tests. First, it must assess and measure risks accurately, including the compounded risks of herding (traders being similarly situated and forced to unwind simultaneously). Second, it must impose significant margin requirements on all exposures. And finally, it must bring all investors and traders — regardless of whether the risk holder is a hedge fund, bank, private equity fund, individual or government agency — under the regulatory umbrella.

Calling for regulation of any sort can seem like heresy to conservatives, especially at a moment when governments in the United States and Europe seem poised to increase the role of the state, and of regulation, in every aspect of our social and economic life. But as I have observed in this space before, the real issue is not regulation per se “but unintelligent and overbearing regulation.” The problem — well, one problem — with the Community Reinvestment Act was that it stymied the operation of the market by refusing to acknowledge and price risk accurately. It did this in pursuit of a utopian political dream. The result was a $1.5 trillion avalanche of bad debt guaranteed by the taxpayer and gobbled up by creative speculators who compounded the problem by once again refusing to recognize the risks inherent in their ingenious financial instruments.

The bottom line is that in calling for intelligent regulation Mr. Singer is not impeding the free market: he is helping to assure its successful operation. The market depends on the candid and publicly available adjudication of risk. That, indeed, is what makes it free. The explosion of highly leveraged financial instruments that depended heavily on inscrutable agglomerations of debt represented a gigantic risk that was never publicly acknowledged nor adequately insured against. We are now living with the results.

Paul Singer expatiates on one side of the social-economic-cultural crisis we face (and make no mistake, the crisis, although it began on Wall Street will have unsettling reverberations throughout society). Charles Krauthammer touches on a complementary aspect of the crisis. The financial crisis, Mr. Krauthammer points out, are for the Obama administration merely “sideshows”–“enormous sideshows,” he acknowledges, but in the end subsidiary to Obama’s main ambition, which is to alter in the most fundmental way the traditional relationship between the individual and the state, to the aggrandizement of the latter and the hampering and circumscription of the former. “His goal,” Mr. Krauthammer observes,

is to rewrite the American social compact, to recast the relationship between government and citizen. He wants government to narrow the nation’s income and anxiety gaps. Soak the rich for reasons of revenue and justice. Nationalize health care and federalize education to grant all citizens of all classes the freedom from anxiety about health care and college that the rich enjoy. And fund this vast new social safety net through the cash cow of a disguised carbon tax.

Obama is a leveler. He has come to narrow the divide between rich and poor. For him the ultimate social value is fairness. Imposing it upon the American social order is his mission.

In short, “Fairness through leveling” — which is to say ” ‘fairness’ through leveling — “is the essence of Obamaism.”

So we have our work cut out for us. On the one hand, Paul Singer is right that we need formulate new regulations to curb irrational and dangerous risk taking. On the other, Charles Krauthammer is right that the Obama administration is poised to employ the enormous power of the state to renegotiate the social contract upon which American society was built. We must, in other words, weave our way gingerly between the Scylla of incontinent, unchaperoned risk-taking and the Charybdis of a rampant new statism predicated on a soul- and enterprise-blighting egalitarianism. Never a dull moment.