While many academic economists promote their pet theories on financial stability, the U.S. financial system continues to suffer on account of its monetary policy. And the Dodd-Frank Act is just another piece of timber on the pile.
Since its passage in July, many have offered their two cents on the benefits (or lack thereof) of the financial reform bill, but I had a chance to hear a handful of prominent economists offer their own take yesterday afternoon.
The event, which was moderated by former Mexican president Ernesto Zedillo, included economists Robert Shiller from Yale, Thomas Cooley from NYU, and Stephen Roach from Morgan Stanley (MS). And until Roach started laying into some of academia’s pearls of wisdom about modern day risk management, it was a moderately boring event.
It took Zedillo 13 minutes to introduce the financial crisis and promote Cooley’s recent books, then he handed it off to Shiller and Cooley, whose main contributions to the debate were to a) support Dodd-Frank and b) mock anyone without a Ph.D. in economics who has worked at the White House.
I’m a big fan of both mocking some of the financial academics in the West Wing and of Robert Shiller. He was my professor at Yale in the mid-1990s and is one of the most important risk managers of our modern day bubble-making economy. Shiller made me smile when he acknowledged that Barney Frank was a political science Ph.D. dropout and has certain barriers of competence when it comes to financial risk management.
But, pleasantries aside, Shiller’s idea that America’s economic resolve will come from the academic world made me sick to my stomach.
Steve Roach’s basic conclusion was that Dodd-Frank is an insufficient solution to this economic mess. While Tom Cooley was mocking the likes of Treasury secretaries who don’t come from the academy, Roach (who got his Ph.D. from NYU) was quick to remind him that the biggest joke of all is watching their academic colleagues at a G-20 summit talk about real-time markets. Zedillo didn’t like that.
While Shiller and Cooley were focused on whether or not Dodd-Frank would have prevented Lehman Brothers from imposing systemic risk on the U.S. financial system, Roach was more concerned with its ability to prevent the next financial crisis. And I agree with Roach’s main conclusion that the U.S. financial system has been compromised on account of its monetary policy. Zedillo didn’t like that either.
This is the debate that we need to have in this country: Are all of our leverage and liquidity problems simply caused by the implementation of an academic ideology that monetary policy should only be used as a blunt instrument on the way down and not on the way up?
Roach knocked the pins down pretty convincingly on what the Federal Reserve’s objectives should be:
1. Full employment (1946 Employment Act)
2. Price Stability (1976 Humphrey-Hawkins Act)
3. Financial Stability (2010 Dodd-Frank Act)
Regarding full employment (economic growth) and price stability (inflation), it’s very hard to argue that the Greenspan/Bernanke academic ideologies of the last decade have worked (there has been no net American private sector job growth in the last decade).
This shouldn’t be surprising; neither Greenspan nor Bernanke saw any success applying their academic theories as practitioners of real-time risk management. Volcker’s tenure as Fed president (which was during the 1980s, when net private sector job growth was over 18 million) was much more successful on both the full employment and inflation scores.
On financial stability, I don’t think Dodd-Frank supporters have any legitimate claim at this point that it can supersede or contain the long-term risks of the U.S.’s current monetary policy. As both Harvard’s Ken Roggoff and Yale’s John Geanakoplos have both recently concluded, understanding financial crises starts and ends with the cycle of leverage — the point at which the debt companies and individuals pile on in the name of growth becomes unsustainable.
The U.S. Federal Reserve and the Bank of Japan (and now the European Central Bank) have all attempted to manipulate the cost of and access to that leverage. Since Paul Krugman used his economics Ph.D. to advise the Bank of Japan to print lots of money in 1997, the academic world hasn’t shown this risk manager, who has a bachelor’s in economics, something that’s actually worked.
Keith R. McCullough is CEO of Hedgeye, a research firm based in New Haven, Conn.