Willem Buiter on How Central Bankers Are Co-Opted

Yves Smith of Naked Capitalism submits:

A reader pointed me to Willem Buiter's blog, and it is a real find. For those who haven't heard about him, he (along with Anne Siber) has proposed a rethinking of central bankers' roles in times of crisis, arguing that they should serve as market makers of the last resort.

One reason to read Buiter, aside from the intrinsic merit of his ideas, is that he is almost certain to capture the attention of policy makers (although they may be loath to admit it, since Buiter is blunt and often highly critical of current practice). But Buiter has the sort of blue-chip economics/regulatory credentials that mean he can't be dismissed easily.

In his current post, "Central banks and the financial sector: a complex relationship," Buiter hones in on the thorny relationship between regulators and their charges.

Regulators often face conflicting directives: while they have to make sure the public at large's interests are served, they also are responsible for assuring that the institutions they oversee are healthy. Where to draw the line between societal and industry interests is often a judgment call. Buiter points out how the deck in the financial services industry is stacked in favor of the regulated (we've seen similar issues come up with the Food and Drug Administration, which critics feel has been too easy on Big Pharma).

With all due respect to Buiter, there is one issue he omits, namely, that in the end, the industry understands its business better than the regulators do. That was not always the case. When change moved at a slower pace, the overseers often had better insight by virtue of looking at practices across many players.

Now, particularly in industries like financial services that feature rapid product and process innovation, regulators are constantly in catch-up mode. In the US, this limitation is further compounded by the fact that the real action is taking place in institutions that for the most part are beyond the Fed's reach.

Thus, when the industry comes in and tells regulators that they've gotten something all wrong, the authorities have to take that view seriously. And of course, the industry, having better data about its own activities than outsiders can readily muster, is generally able to make a persuasive case, or at least muddy the waters considerably.

Some of Buiter's observations echo those of Jim Grant in today's New York Times , but Buiter also notes that Wall Street seems to be an example of market failure, since compensation bears little resemblance to the value of the contribution to society.

That last issue is easy to explain. It's called barriers to entry.....

Buiter concludes that there is little one can do to remedy this situation, save locating central bankers far away from a nation's financial capital and making sure that the top echelon is not dominated by those who think the universe revolves around financial markets.

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