Photo: Courtesy of Bloomberg
Gretchen Morgenson is on the prowl this morning, and she has Dodd-Frank in her sights.Writing in her “Fair Game” column in the New York Times, Morgenson interviews the authors of a recent paper that proposes creating an agency modelled on the Food and Drug Administration that would monitor financial products.
Such an agency is needed, she and the authors say, because the central idea of Dodd-Frank — greater transparency — falls short of real reform.
” ‘My major concern about Dodd-Frank is that the basic philosophy behind it is to improve disclosure, the traditional way of addressing market failures in a way that is thought to be helpful but not too intrusive,’ says Eric Posner, a University of Chicago professor and co-author of the paper.
But people tend to ignore the warnings on drugs, he says, “so we draw the line and say, ‘You can’t buy that product,’ ” he says.
The authors’ proposed Financial Protection Agency would ban purely speculative products like naked credit-default swaps (when the holder doesn’t own the underlying security) that they argue add no net value to society.
“Financial instruments could be judged by whether they help people hedge risks — which is generally beneficial — or whether they simply allow gambling, which can be costly,” Morgenson writes.
“We tried an experiment with a very radical form of deregulation that has very little basis in sound economic science,” E. Glen Weyl, Posner’s coauthor, tells Morgenson. “What we’re advocating is to do the best we can to put the genie back in the bottle.”
Another assumption the authors make is that banks have figured out how to game ratings agencies — who in theory already perform the role of risk evaluator — by making products technically legal but without actually reducing their inherent risk.
Morgenson says she’s under no illusions that creating such an agency isn’t likely to get far in the current political environment.
Still, she writes, the paper is a sound rejoinder to those who believe that complex financial products “are among America’s great inventions.“