Fed Critic Economist Explains Failure of New Financial Regulation

Raghuram Rajan is a University of Chicago economist that’s most famous for attending a 2005 dinner honoring former Fed chairman Alan Greenspan just to tell him that his Fed decision making was leading the nation toward disaster. In a recent interview, he discusses how new US financial regulation continues to miss the mark.

Here are two highlights from Time Magazine:

* Is there historical precedent for using cheap credit as a political palliative, as you call it?

Absolutely. Both across countries and within the United States. In many ways, farmers toward the end of the 19th century were falling behind the rest of the population. A big piece of the Populist platform was to push for more credit. The result was a tremendous expansion of banks in the early 20th century. Some would argue that the immense extension of credit to the farm sector in the 1910s and ’20s was a precursor to the Great Depression…

* How do you rate the financial reregulation coming out of Washington? Because what you’re talking about doesn’t sound like what Congress is talking about.

I would ask a more fundamental question than is being asked, which is, Why were markets so oblivious of the risks being taken? I would argue a big reason was because they believed the markets would be bailed out by the government, and that expectation has been confirmed, with the government intervention in the housing markets and the credit markets and the Fed pushing enormous amounts of liquidity.

Even today, Rajan sees the Fed as still unwisely employing every arrow in its quiver to rescue the financial system even as predictable crises unfold. The Fed regularly responds with measures like easy credit that are bound to bring about another bout of the somehow evergreen “perfect storm.”

The Fed actively intervenes, time and time again, to extinguish economic fires with liquidity, and with little regard for the consequences of loose monetary policy. This is, of course, despite the lessons of even recent history. As Rajan remarks, “I think we are in a similar situation now.”

You can read more of the question and answer session in Time’s coverage of the economic seer that says we’re not addressing the cause of the crisis.


Rocky Vega,
The Daily Reckoning