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Antique Economic Theories: Priceless or Worthless?

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For financial industry to profit, revamping regulators must be part of the deal.

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A Properly Leveraged Economy

Paraphrased from the movie, Philadelphia: What do you call a thousand economists chained together at the bottom of the ocean? A good start.

Most investors are largely unaware of the critical battle brewing for the soul of the global economy, driven primarily by the still-unresolved future structure of the finance industry. I introduced several key elements of this in my recent blog posting, In Defense of Financial Innovation. In that posting, I took the side of Secretary Tim Geithner in his quest to keep the financial infrastructure intact, while moving the regulatory ball forward toward a sorely needed revamping of the oversight capacity of government.

The opposing view is held by traditionally trained economists such as Paul Krugman and Joseph Stiglitz, who argue that banking should go back to school - as in the old school form of banking: Make a loan, hold the loan to maturity. At the risk of taking on not one but 2 Nobel laureates, this old-school thinking is wrong and bad for the economy on 2 levels.

First, what went wrong occurred not because of the wizardry of Wall Street, but because of the lack of proper and prudent oversight. Regulators asleep at the switch allowed the animal spirits and their desire to "dance while the music was playing" to run amuck, resulting in excesses that cut across a wide swath of the economy. What needs to be appreciated is the fact the inventive nature of self-interested parties in a free-market capitalistic system will always cleverly run ahead of the much slower regulatory structure - made all the worse with a nineteenth century laissez-faire ideology that permeated the views of nearly all the actors on the financial and economic stage (most notably, the former Fed Chairman himself, Alan Greenspan).


Perhaps more egregious is the second reason why Krugman, Stiglitz, et al, are wrong, as it lies directly in the wheelhouse of their expertise: the economy. Is it not clear to this group of esteemed individuals that a much diminished financial infrastructure that they support virtually guarantees an economic growth rate far below its potential? Is it really advisable to advocate for a dumb-downed banking structure that virtually guarantees a sub-optimal growth rate? And how far back in banking time do our old-school economists want to go? Perhaps back to Lord Polonius?

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