Monkeys and Markets

George Soros published an editorial in the FT today, criticizing the Paulson financial industry regulation "reform" (who are we kidding here, the guy is the former head of Goldman Sachs -- reforms are for the little people) and, more importantly, providing some suggestions of this own.

• Create a CDS exchange with margin requirements to solve the counterparty risk problem that led the Fed to bailout Bear.
• Bailout underwater homes either through an outright purchase of mortgages or through modifying bankruptcy laws to allow judges to dictate workouts with creditors

The first of these ideas sounds extremely smart. I'm more skeptical about the second one, but that's probably because I would still have to pay for it, even though I don't own a house in the US. Maybe it's necessary to have the government rescue home owners. Certainly it is politically inevitable.

The larger point Soros makes -- that regulation and risk models to date have been based on a sort of "market fundamentalism" -- also strikes me as a good one. I'm generally and as a matter of principle in favor of markets, but I also know that they are not always efficient and do not grow on trees. To have markets that serve their purpose (distributed coordination, information transmission, and tending to equilibrium) you have to create them, with sensible rules everyone is forced to play by, designed to produce the outcomes you were looking for. "Everyone" in this case, refers to a bunch of former monkeys, and when designing your sensible market rules, it pays to keep this in mind. Unfortunately, the regulators are themselves former monkeys (either of the two groups whose professional success depends on more bailouts), which may account for the fact that crises like the current one are always taken to mean more regulation, especially for people who didn't cause the problem, rather than simply better regulation.