The ideology of financial instability

Should we have a cabinet minister responsible for financial stability? Peter Franklin thinks so:

Devoting a Cabinet minister to financial stability is no guarantee of financial stability, but it would help and, if nothing else, would send a message to the anxious savers and pension fund holders of Middle England that we take their concerns seriously.

Matthew disagrees:

Just about the only way you could make things worse is to put a politician in charge. This isn't an area where there are many ideological issues at stake that should be decided democratically. It is, instead, an area that requires expert and experienced judgement.

I agree with Matthew that it's a bad idea to put a politician in charge. But I disagree that this is an area requiring expert judgment. The thing is, financial stability is an ideological question, on which experts disagree. There are three distinctive positions here:
1. Free markets create financial stability. Financial entrepreneurs invent clever ways to split risk into small bundles and sell it to those best able to bear it. State intervention can destabilize the system by introducing both inflation and moral hazard; if lenders think they'll be bailed out by interest rate cuts or loans from the taxpayer, they'll take excessive risk.
You might think this view is even less credible now than a few months ago. Not necessarily. Many of the losses on ABSs are losses of "internal assets", which are redistributions of wealth rather than aggregate losses of real wealth. And the stock market only looks unstable because you look at it every day. In the last two years, the All-share has risen at an annualized rate of around 5 per cent - in line with its average for the previous 105 years. The casual observer - and serious retail investors should be no more - would never guess there was a problem.
2. Markets are inherently, endogenously unstable, as Hyman Misky pointed out. Good times cause banks and investors to become over-exuberant and lend too much. When reality dawns, falling asset prices and tighter loan standards cause recession.
3. Markets would be a force for stability, if only they were better developed; this is Robert Shiller's position. If we had markets in occupational or industry risks, ordinary people could get better insurance against the economic risks they face. One job of government should be to encourage the "financial services" industry to stop being an oxymoron and start developing these markets.
To have a minister for financial stability in the absence of agreement on these questions is pure managerialism - the belief that the good judgment of someone in power can adjudicate between competing theories. And of all ideologies, this is surely the one with the least to commend it.

Comments

[reason]

As for Robert Shiller's position, sorry but I don't think it is tenable. Private insurance is basically a scam. There are huge adverse selection problems and there is no guarantee that your claim will be honoured when you make it. Private insurance is there if you don't need it.

[kinglear]

Putting anyone - especially a politician - in charge of something usually buggers it up completely. I always quote London - noone has ever said " so many pints of milk, so many sheep, so many apples etc etc " have to be delivered daily. But somehow, everyone gets fed.
Amazing what self-interest and the profit motive can do, all on its own, isn't it??

[kinglear]

S&M- you should do a post on how Brown G,. used to rant on about stability and prudence, how the cycle of boom and bust had been broken and all such other drivel, clearly showing he had and has no more grasp of Economics than er Mr. Bean

[Alex]

Hmm, I wonder how London gets its water and sewage? Thousands of small, competitive, self-interested water companies?

Nuhu!

[Matthew Sinclair]

Hmm... I'm going to simplify a little but isn't it pretty necessary to have some authority for financial stability thanks to deposit insurance and the like? Doesn't that mean that we need to have some body or someone in charge?

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