Gillian Tett's micro-historical view of the crash is extracted in the FT. Quite apart from satisfying a sort of morbid fascination about which regulators had what wooled pulled over their eyes, it highlights another aspect of the great waste of the last 20 years of finance-mania: what passed as innovation.
In this extract, she tells the story of one team of bankers doing the first securitisation, or "Bistro" deals as they were then called. The "innovation" seems amazingly paltry: "let's bundle some loans together and resell them". It seems an absolute triumph of form over substance. It is "innovation" from an age that thinks that packaging is an art. Harry Markowitz, a 1950s economist, formalised an investment practice that had been known for thousands of years: you don't put all your eggs in one basket. What the bankers did in the Tett story was to offer a very slight increase in the number of baskets available for egg-storage. This is innovation in the same way that the stall-holder at my local streetmarket innovated when she offers a basket of mixed apples and pears for a pound, rather than offering only apples or only pears. (I will congratulate her on her breakthrough next time).
The "innovation", of course, was not in weaving another basket. It was in tricking regulators to accept that some magic had been done to make risk disappear. What is fascinating in the Tett story is how that regulatory bamboozlement happens. Find a firm that falls outside the regulations; get them to perform the magic trick; then get your regulators to feel that if they won't let you claim magic, they'll lose their regulatory empire.
The Virginia and Chicago schools of economics love regulatory competition. This is exemplified by the image of "voting with your feet": if you are abused by one sovereign, some degree of regulatory competition means you can move to another sovereign. This "divide and rule" should help keep sovereigns honest.
But the trouble is that the process does not keep sovereigns honest---it forces them in the direction of those who can exert pressure. So if the pressure is to be dishonest, this is a recipe for making sovereigns even worse than they naturally would be.In the case Tett describes, this is a process of putting pressure on a regulator to ignore proper misgivings.
Yet another case where we'll have to learn that competition is not good per se, but good only if the pressure moves us in the right direction. The religion of competition from Chicago and Virginia, just like the innovation in the finance sector, is the abandonment of substance to form.
