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Madness Posing as Hyper-Rationality: OMB's Assault on Effective Regulation

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Reprinted from neweconomicperspectives.org

In a rational world the Office of Management and Budget (OMB), under Presidents Bush and Obama, would have responded to the financial crisis by demanding an emergency effort as a top national priority to develop superb regulatory capacity in the financial sphere and in many other fields. Regular readers will recall the questions I emphasize we must answer -- why do we suffer recurrent, intensifying financial crises? That may sound like one question, but it asks multiple questions. The two most critical are:

  • What is causing our financial crises?
  • Why are we failing to learn the correct lessons from the crises and instead making finance ever more criminogenic?

The tragedy, of course, lies in the answer to the second question. It is obscene that we are making things even worse in response to each of our crises. The fact that we repeatedly do so demonstrates how criminogenic theoclassical economics is and how dogmatic those economists are. This makes them incapable of learning the correct lessons from the crises. Instead, they double-down on their criminogenic policies and produce even more perverse environments.

OMB and Fed are the Temples Devoted to the Worship of Theoclassical Economic Dogmas

The OMB has failed to ask itself, much less answer, either question. Answering those two questions would lead the OMB to ask similar questions about other fields such as how to protect the environment through essential regulation. If the OMB were to ask itself these questions, and answer them honestly, they would have to give up their dogmas. Instead, those dogmas prevent them from even asking the correct questions and would make them incapable of answering the questions honestly even if they were to face the questions.

Four Lessons that OMB Failed to Learn from the Crisis

Rather than leading the emergency, top priority effort to adopt the regulations to end the criminogenic environment in finance, OMB remains a leader of the effort to prevent effective regulation. There were four obvious things that even OMB should have learned from the financial crisis if it were even making a pretense of trying to learn from the crisis. First, economists were the problem, not the solution and the theoclassical economists who dominate OMB under every administration should be excluded from any policy role because of their record of repeated, epic fails.

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Second, the paramount factor driving the crisis was that identified by successful regulators, economists, and white-collar criminologists over two decades ago -- epidemics of accounting control fraud.

Third, the epidemics are not random events. They are produced by intensely criminogenic environments. Among the most destructive forces shaping that criminogenic environment three de's" -- deregulation, desupervision, and de facto decriminalization. The CEOs that lead control frauds deliberately create Gresham's dynamics in order to suborn professionals that are supposed to serve as "controls." Control fraud theorists and behavioral finance scholars agree with effective regulators that "information disclosures" rules and guidelines typically fail completely to protect consumers and investors and to achieve market efficiency.

Fourth, the methodologies used by economists, relying primarily on econometrics and financial models will support the worst possible policies in the presence of material accounting control fraud. The models are inherently and devastatingly false because they implicitly assume out of existence the criminogenic environments that produce the fraud epidemics that drive our recurrent, intensifying financial crises.

In sum, OMB should have realized that its passionate embrace of the three "de's," failed theoclassical dogmas, criminogenic policies, and horrifically wrong econometric studies and financial models was a major cause of our problems. Instead, OMB recurrently doubles-down on its destructive dogmas and creates ever more criminogenic environments.

OMB's Primer: Not even an Attempt to Learn the Lessons
OMB has created a "Primer" on "regulatory impact analysis" to explain how agencies must justify adopting rules.

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The Primer is written in a style that is redolent with the authors' dogmatic belief that it represents the embodiment of hyper-rationality and that any reasonable person would agree that its precepts represent an indisputable ideal. OMB's self-delusion is total. Consider first the words that the Primer does not contain:

  • Gresham's dynamic
  • Fraud or Control Fraud
  • Looting
  • Crime
  • Criminogenic
  • Crisis or Systemic Crisis
  • Bubble
  • Deregulation
  • Desupervision
  • Decriminalization
  • Prosecution
  • George Akerlof
  • Behavioral finance

The Primer uses the word "model" only once to urge "peer review" for "novel" models. It does not warn that conventional financial models inherently overstate asset values and that the problem would arise for an agency if it used the common -- failed -- model and that the solution would be to give such common models no consideration.
The Primer Would Have Caused the S&L Debacle to Grow Catastrophically

The Primer ignores modern white-collar criminology and behavioral finance. It ignores past financial regulatory successes. It ignores past financial regulatory failures created by the three "de's" -- which the Primer continues to champion. The Primer is therefore wholly anti-scientific and anti-common sense. Had the Federal Home Loan Bank Board been governed by the Primer in 1983-1987 when Chairman Edwin Gray reregulated the industry, or in 1990-1991 when the Bank Board's successor agency, the Office of Thrift Supervision (OTS) drove (what we now call) "liar's" loans from the S&L industry, the OMB would have blocked the reregulation that was essential to stopping the surging epidemic of accounting control fraud. The result, as we can now understand by reviewing the current crisis, would have been to add many trillions of dollars to the cost of the S&L debacle and the hyper-inflation of real estate bubbles that would have caused a financial crisis and a severe recession.

Recall what our strategy was in containing the S&L fraud epidemics. In both cases -- 1983 and 1991 -- we recognized that we were dealing with accounting control frauds that would create multiple Gresham's dynamics and produced endemic fraud. We acted in each case while the S&Ls involved were reporting high earnings. We do not have to hypothesize what conventional and theoclassical economists would have recommended in such circumstances, for prominent economists lined up in unison to denounce our reregulation as irrational and to argue that we should be encouraging the practices we were banning because the S&Ls employing those practices reported high profits.

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http://neweconomicperspectives.org/

William K Black , J.D., Ph.D. is Associate Professor of Law and Economics at the University of Missouri-Kansas City. Bill Black has testified before the Senate Agricultural Committee on the regulation of financial derivatives and House (more...)
 

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