Commenter Will in N.O sums up the problem with hoping that a regulatory body can prevent the next big crisis:
You touch on something very interesting here when you point to “lack of a regulatory body willing to admit the instruments existed” as a problem.
I believe this to be systemic, i.e., Wall St. will always be one step ahead of the regulators because of massive compensation disparities. New regulations are sure to close down some of the more egregious practices that created the most recent bubble (changes to bond rating practices, for example). But it’s nothing more than slamming the barn door when the horses are already gone.
We can safely assume that regulatory changes ensure that will not have another Internet bubble or another Subprime bubble. We can also safely assume that we will get a brand-new, different bubble because history has shown that when there is a huge amount of money in cash and treasuries just sitting on the sidelines, it will find somewhere to go. And when the financial technology is created to amplify and leverage that bubble, the regulatory agencies will be no more interested in restraining it than they were in previous bubbles.
As much as I enjoy Michael Lewis’ writing, I think he is wrong on at least one count here: there will always be people lining up to give the John Merriweathers of the world enough money to do what they do. Plenty of people made a lot of money in the subprime bubble and salted enough away to remain very, very wealthy. There will always be enough other investors who think they’re going to be the guy who gets out in time.
Why does this matter? Because it lays clear how counterproductive the bailouts are. They’ll do two things:
1) Reward people who made bad bets, thereby providing incentive for event MORE people to make bad bets next time. After all, if I know I am going to be the sucker stuck with the bill, I might as well at try to make some of that up in advance.
2) Drive inflation. For those investors feeling burned by the subprime bubble and cautious about fueling the next bubble with money that’s in cash and Treasuries…a few quarters of 7% inflation will push ’em right back in the pool.
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