Watching our choleric Secretary of Investment Bankers Treasury and his professorial Federal Reserve sidekick, Ben Bernanke, grope for solutions to the market’s gyrations has left me with a sense of morbid fascination. I deeply appreciate the immense challenges and their efforts to calm markets and address a poorly understood credit freeze. However, as I consider the regualtory lurches reflecting all the grace of frankenstein breakdancing, I cannot help but wonder what are the longer term impacts of these crisis driven steps?
The reason I raise this issue is that I recall it was regulatory intervention into capital markets that was a major contributor to arriving at this point. It was lax regulatory policy in credit combined with excess liquidity that were central contributors to widespread credit abuses and inflated asset prices. Are we simply enabling those that are drunk in market excess and pushing off the crisis to another time? And if so, how much will it be amplified?
Central to the proper functioning of capital markets is the concept of price discovery. This is the process whereby market participants find a trading price that resolves a complex mixture of intrinsic value, liquidity, speculation, and pragmatic needs to hold or sell a financial asset. When this price discovery mechanism is upset, it requires later, larger reactions in order to attain normalization of price discovery. By avoiding the pain today, are we setting ourselves up for deeper, more consequential market problems later? My great worry in this absurd, black comedy that our financial regulators are conducting is the question, “Are we now caught in a market intervention positive feedback loop requiring successively stronger measures in order to keep an asset bubble inflated because the pain of correction becomes successively more dangerous?”
And while I make light of the concern, I am not deluded about the compelexity or subtlety of the markets. I remember well the lessons of Long term Capital Management- the best and brightest among us are not (yet) able to master the complex system of market dynamics. From my vantage point, each time we seek to avoid the economic discipline of market corrections by interventions, it reappears later in a deeper, steeper and more consequential correction.