BY NICHOLAS JOY
When it comes to the Treasury Department’s proposals for new financial regulations, Judge Richard Posner ’62 would “be perfectly content to have them never adopted.”
Posner spoke at noon on Wednesday, November 18 about financial regulatory reform and the Obama Administration. His talk took place in Harvard Law School’s Ropes Gray room and was sponsored by the Federalist Society.
Posner was appointed to the United States Court of Appeals for the Seventh Circuit by President Reagan and served as Chief Justice of that circuit from 1993 to 2000. He is also a Senior Lecturer at the University of Chicago Law School and has been identified by the Journal of Legal Studies as the most cited legal scholar of all time.
In his talk, Posner said that he strongly disapproved of a June 17 Treasury Department report on proposals for financial regulation and, more generally, “the whole business of reform.” He said that the report and the reform proposals concerned him for three reasons.
First, he said that there was no authoritative understanding of the causes of the current financial downturn. He contrasted the approach of the bi-partisan Financial Crisis Inquiry Commission with the non-partisan 9/11 Commission, saying that the commission tasked with investigating the financial crisis had been filled with activists from each party and was being “extremely sluggish.”
“The proposals precede any systematic study of what happened,” he said. “Whatever was good about the 9/11 Commission is turned upside down.”
Second, Posner took issue with passing reform measures during an economic recession. As an example of the potentially perverse effects such reforms could create, he described how recent regulation on credit cards had driven up credit card costs and frozen that aspect of the economy.
“The reform is going to impede the recovery,” he said. “The biggest problem in such a collapse is psychological. The time for ambitious regulation on risky behavior is when the economy is booming.”
Finally, Posner worried about the lack of concerted international action, a development he called “most disturbing.” He believes that without international cooperation, any attempt at increasing regulation would prove fruitless because of the ability of finance to move from country to country.
“The financial industry is already global. They will go anywhere,” he said. “If major countries restrict their banks it will create more opportunities for other countries.”
He added that taking action sooner rather than later could make coordinating international regulation of finance more difficult.
“If Congress has already acted, our flexibility will be impaired,” Posner said.
According to Posner, a significant concern for the prospect of taking a successful approach to financial regulation is that the U.S. is in “the awkward position that many of the people most responsible for the economic breakdown are people in high positions” in the current regulatory regime. By Posner’s view of the causes of the economic crisis, Federal Reserve Chairman Ben Bernanke, Treasury Secretary Timothy Geithner, and Director of the National Economic Council and former Harvard University President Lawrence Summers all bear some blame.
Posner said that the Federal Reserve’s policies under Bernanke and his predecessor, Alan Greenspan, kept short term interest rates too low for too long, driving a surge in demand for housing. Posner said that Bernanke failed to heed warnings about the dramatic rise in housing prices this produced.
“He denied and the government denied that there was a bubble,” Posner said. “It created an opportunity and incentive for people to take on an enormous amount of debt. There was a kind of an orgy of spending and it collapsed.”
By the middle of 2007, Posner observed, it was clear that there were problems with mortgages and the housing market. He said that, even as the situation got worse, “at every juncture the Fed under Bernanke thought the problem was contained.”
According to Posner, a critical mistake was made when Bernanke and Geithner, then President of the Federal Reserve Bank of New York, decided to allow the financial-services firm Lehman Brothers to fail. This caused an investor panic and a run on banks.
In Posner’s view, Bernanke and Geithner have chosen to put the blame on banks rather than take responsibility themselves and acknowledge the role that unsound monetary policy played.
“This sort of populist theory is easy to sell,” he said. “If you tell them bankers are greedy and overpaid they’ll say, ‘Fine, sounds right.'”
What Posner hopes to see going forward would be a return to a separation between commercial banks and other financial-services firms. He said that if commercial banks were sealed off, tightly regulated, and insured by the FDIC, they could provide “a safe backbone” even in another financial crisis.
He said that allowing commercial banks to diversify themselves with riskier investments creates a dangerous and unstable mix. The cultures of the safe and risky businesses are incompatible with one another.
“No one respects risk managers because they don’t create profits. All they do is stop deals, like lawyers,” Posner said. “The traders are the real stars. There are always these tensions.”