Freshwater Economist Cochrane On Free Market Banking

This is from one of Krugman's critics who argues that excessive regulation caused the banking problem.  Nevermind that the part of the financial system that collapsed was almost completely unregulated and that is what took down the regulated part.  GSB news—Initiative on Global Markets Looks at Market Turmoil:

In the recent turmoil in financial markets over the failure of subprime mortgages, investors should remember “caveat emptor,” or let the buyer beware, said John Cochrane, Myron S. Scholes Professor of Finance. “These are matters for buyers and sellers, not regulators,” Cochrane said

Incredibly, he said this on September 25, 2008! I think most economists would have disagreed at that point.

“Nobody else gets hurt if you buy a lousy mortgage pool,” Cochrane said. “The government doesn’t need to write a new rule every time someone buys a rotten tomato. Investors will demand the right amount of transparency, complexity, and risk-sharing – or monitoring of mortgage pools – unless they all get bailed out and learn to count on a bailout instead.”

Actually there is regulation of rotten tomatoes. The FDA, Agriculture department, and various state health departments regulate rotten tomatoes. There is also tort law.  Some of it probably hurts consumers, but most consumers want some sort of regulation of the food supply and it is even harder to imagine a money supply that is not regulated.

The government creates some of the moral hazard that caused excessive risk-taking, but the market created much of it too.  Whenever someone invests other people's money, they have an incentive to take excessive risks and that is largely what the finance industry does. See my entry about Endogenous Business Cycle Models.