Gary Becker Interview in the Wall Street Journal

http://online.wsj.com/article/SB123759849467801485.html

A very interesting interview. It is well worth reading the whole thing. One particular part that caught my eye was Becker's comments on policy during the current economic crisis.

Yet the professor is no laissez-faire ideologue. He says we have to think about what the government can do to "moderate the hit to the real economy," and he says it should start with "the first law of medicine: Do no harm." Instead it has done harmful things, and chief among them has been the "inconsistent policies with the large institutions . . . We let some big banks fail, like Lehman Brothers. We let less-good banks, big [ones] like Bear Stearns, sort of get bailed out and now we bailed out AIG, an insurance company."

Mr. Becker says that he opposed the "implicit protection" that the government gave to Bear Stearns bondholders to the tune of "$30 billion or so." So I wonder if letting Lehman Brothers go belly up was a good idea. "I'm not sure it was a bad idea, aside from the inconsistency." He points out that "the good assets were bought by Nomura and a number of other banks," and he refers to a paper by Stanford economics professor John Taylor showing that the market initially digested the Lehman failure with calm. It was only days later, Mr. Taylor maintains, that the market panicked when it saw more uncertainty from the Treasury. Mr. Becker says Mr. Taylor's work is "not 100% persuasive but it sort of suggest[s] that maybe the Lehman collapse wasn't the cause of the eventual collapse" of the credit markets.

He returns to the perniciousness of Treasury's inconsistency. "I do believe that in a risky environment which is what we are in now, with the market pricing risk very high, to add additional risk is a big problem, and I think this is what we are doing when we don't have consistent policies. We add to the risk."

I am becoming increasingly convinced that the big lesson from this crisis once the dust has settled will be that government policy needs transparency. The take-away from the Asian financial crisis in the 1990's was that banks and finance needed transparency. This crisis is showing that governments need to convey information on the fundamental rules or principles which drive policy and when people get mixed signals or the signals are not easily interpretable, the result is an big uptick in uncertainty. So called pragmatic policy-making that evaluates each mini-crisis independently and lets one firm fail while another seemingly similar firm is bailed out is counterproductive.

The geniuses at Econosseur (disclosure: one of them has the office across the hall from mine) have posted a nice clip from a recent South Park episode that illustrates this rather nicely.