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Berkshire Hathaway
On Better Regulation

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By rclosch
December 4, 2009

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We have clearly passed though the period where deregulation was popular, and now are currently embarked on a period where there is a lot of clamor for new regulation. Before we get too enamored with this prospect I think it might be well to review the regulatory successes (or lack thereof) of the last one hundred years. In the United States the Twentieth Century began with the re-establishment of a central bank with the Federal Reserve Act of 1913. Looking back I think that we will have to admit the Federal Reserve has been something of a mixed bag. In "The Lords of Finance" Liaquat Ahamed blames The Great Depression of the world's four largest central banks;

"... in this book I maintain that the Great Depression was not some act of God or the result of some deep-rooted contradictions of capitalism but the direct result of a series of misjudgments by economic policy makers, some made back in the 1920S, others after the first crises set in-by any measure the most dramatic sequence of collective blunders ever made by financial officials."

The return to the gold standard in the twenties with the price of gold fixed, had the effect of removing from gold producing companies any incentive to increase production the result was that the production of gold 1920's lagged behind the increase in the World GDP. With the price of goal fixed at 1914 prices liquidity was being drained from the countries that needed it the most, and sent it flowing to the United States to create a stock market bubble. To make things worse the stagnation of the world's money supply was at a time when the countries where struggling out from under massive debts from World War I, and the last thing they needed was deflation.

The result of the dysfunctional gold standard was eventually a series of crisis that started with a depression in Germany in 1928 and was followed by the stock market crash in America in 1929 and then the serial bank panics that started in 1930. By 1931 Europe was already in a depression that became considerably worse than anything that was subsequently experienced by the United States. The economic collapse caused political instability in Germany that brought Hitler to power, and gave us World War II, the holocaust, and eventually the deaths of fifty million people.

What is clear from this story is that much of the disaster of the 1930's was the unintended consequences of action by well intended, reasonably intelligent people who thought they were doing the right thing. Clearly when it comes to regulations and regulators good intentions and reasonably intelligent is not good enough.

That is not to say that we learned nothing from the lessons of the 1930s. So far we have been able to avoid many of the blunders made by the central bankers then. We are only one year into this crisis and the last chapter of this story is yet to be written, but it appears the FED has performed well post crisis. Pre-crisis is a different story, the FED's performance in feeding Bubbles while not quite on a par with the central bankers in the thirties still leaves Greenspan at the top of my "Perp" list.

Alan Greenspan considered himself a libertarian, yet when put in a position of power he became a compulsive economic tinkerer who added to our economic lexicon such marvelous concepts as the "goldilocks economy", "the soft landing", the "Greenspan put", and the bailout of Long Term Capital Management. We do not know how Ann Rand felt about "Moral Hazard" but clearly Greenspan was not familiar with the concept. The FED had a lot of help in bubble building from their friends in congress and executive branch. Liberal legislators passed laws to encourage the spread of home ownership to people with limited incomes (i.e. limited ability to pay the mortgage but presumably not a limited ability to vote in the next election) that pretty well mandated the de facto bankruptcy of Fanny and Freddy. Greenspan in his book "The Age of Turbulence" said that while he was constantly fielding calls from Capitol Hill pleading for the FED to lower interest rates, he did not in his seventeen years in office receive one call from a legislator requesting he raise interest rates. These Congressmen having now demonstrated their good intentions and economic wisdom by past behavior are now asking that they be given more authority over the Federal Reserve Board.

It is certain that the regulations inspired by the great depression have done some good. For example the existence of the FDIC has successfully prevented the kind of bank runs that we saw in 1931-1933, but all the laws and regulations of the "New Deal" did nothing to change the cyclical nature of our economy, the imperfect nature of human existence, or prevent the current crisis. I would argue that the FED by sustaining the up cycles and delaying the corrections may well have turned what should have been a normal correction into a crash. I may be a bit dim but do not understand how anyone could believe that our economic performance will be improved by giving more authority to the congress.

I am not arguing against regulation. No society can function without rules, but good rules should be simple and they should be as unobtrusive as possible. Much as we would like too, we cannot design a perfect economic system, and the rules we write now will benefit if we start with low expectations. Pain is the mother of wisdom but that does not mean that all lessons should be written into laws or that more power must be given to the government.

It important to remember as we try to assemble rules that will prevent future disasters that this is at best a naive pursuit. Further that the one great lesson to be learned from the last one hundred years is that while the power of government to do good is limited and ambiguous, its power to do evil (even unintentionally) is unlimited.