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Article Excerpt
[ILLUSTRATION OMITTED]
In the current atmosphere, one could be forgiven for thinking that the current financial meltdown was due to a technical engineering problem, or at least that the U.S. Treasury thinks so. The complex proposals Treasury recently put forward--for stress tests, bad asset pricing, and bank recapitalization without government control--seem consistent with this belief. They treat the financial crisis as a failure of specific mechanisms subject to a technical fix by the more clever engineers now in charge. If only the risk models used by investors and supervisors were less short-sighted, less blindly reliant on so-called Gaussian copulas; if only banks' private managers and public supervisors had the intellectual or computational firepower to see how various risks interacted; and thus, if only we can carefully realign incentives and information flows, we can fix the financial system.
Yet it was not technical failures, mistaken models, misaligned incentives, computational errors, or gaps in risk monitoring that led us to the financial wreckage we see today. These all happened, but they were symptoms, not causes. What led us to today's financial wreckage was a decade of lax governance and supervision of financial companies. And that permissive environment was itself the result of a politically powerful view in favor of...
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