Cognitive Capture

Last August at the Federal Reserve's Jackson Hole Conference a European economist named Wilhem Buiter told his audience the federal regulators of the financial services sector had become the victims of cognitive capture and were no longer capable of regulating the institutions subject to their purview in the public interest. In this May's Atlantic Monthly, Simon Johnson, a former head economist of the International Monetary Fund will make, in essence, the same argument, in a more provocative form. He argues that the current American financial crisis resembles those that have struck emerging markets economies in the last generation not only in the unexpected suddeness of its onslaught (a liquidity event), but, more importantly, in the extent to which the local financial institutions have succeeded in establishing autonomy from local government, and, indeed, compelling government support for their own failing strategies.

Events since last August have tended to confirm Buiter's argument, and Johnson's article is a reasonable explanation for the ad hoc and disjointed efforts to date of the federal government to address the collapse of the money center financial institutions. In defense of the Paulson-Geithner approach, it's not clear that any better alternative was available, or, for that matter, is available yet.

The obvious takeaway is that the interests of the financial institutions, their executives and the providers of their capital must be subordinated to the public interest. A further takeaway is that the economic power and political influence of the financial elite must be clipped. The human part of this latter is oddly difficult, since it requires summarily dispatching a leadership that, as recently as a year ago, was popularly lionized in the cult of the billionaire CEO. Finally, and perhaps most difficult, some alternative to the ideology of the perfect deregulated free market has to be developed to underpin a different approach to the provision of financial services, and that is very hard to do on the fly.

The other, huge problem with the Buiter/Johnson argument is that it amounts to a restaurant review when what is called for is a new recipe. Still, it's a start . . .