Sunday, November 23, 2008

Brad DeLong tries to adjust the thermostat

Brad DeLong opines on the thermostat model in his discussion of Felix Salmon's reaction to Bush's speech about markets. Here is the key bit:
Oh, come on. The problem with Frannie wasn't "government involvement in the market" -- it was government deliberately exempting Fannie and Freddie from the capital-adequacy rules which applied to everybody else, and thereby encouraging them to maximize the amount of leverage they took on -- all in the name of "encouraging homeownership". What we needed was precisely more government: a Frannie regulator with teeth, and a government which refused to let nominally-private corporations lever up to obviously-dangerous levels. The implicit government guarantee wouldn't have been a problem if it wasn't for the amount of leverage involved.
The question is: which one is "more government"? Is it the out of control Frannie and Freddie or is it the regulated Fannie and Freddie? Is it more government when the government sets up a stupid regulatory inconsistency (and one that just happens to generate a lot of perks for people in Congress) which can in some sense be viewed as "less" or is it more government when the government applies regulation consistently, which happens to be smart in the second-best sense that if you are going to have Fannie and Freddie (itself not so obviously a good idea) you should at least not exempt them from the same rules as other similar private entities? I think Brad's post does a good job of illustrating the general weakness of the thermostat model of government and its lack of value as an analytical tool. What you want is the right kind of government, something that a simplistic more or less view captures only at the crudest level.