Free markets in the financial industry

I had a crazy thought. There is a huge economic policy debate as a result of the financial crisis about how much regulation is necessary. The Chicago School, the main proponents of the free market approach, is based on Milton Friedman’s work. The best description I have ever seen is here. Pro regulation is coming from every angle now in a variety of forms.

So why not let the free market decide. Why don’t we create two types of financial institutions? We used to have separate regulations for investment banks and retail banks. This division was blurred by the deregulation trend of the past few decades and obliterated in the past year. Why not recreate it, but along a different dimension?

Lets create one stream that is fully regulated. In exchange for strict capital requirements, oversight, and following a consumer bill of rights of some kind, these institutions would be eligible for FDIC insurance and while not an implicit guarantee (we don’t want the Freddie and Fannie fiasco redux) perhaps they would get some kind of assistance in the face of a financial meltdown. Depositors and investors would know to expect lower average returns and less upside on their investments in exchange for less downside risk.

The other stream would have looser requirements and less regulation. But they would have no insurance and absolutely zero chance of any public assistance no matter how bad things get. Investors and depositors in these banks would know that they were taking bigger risk for the bigger potential returns of financial innovations like CDOs and CDSs.

Of course there are lots of details that I haven’t thought through that could make this a silly idea. But as an approach, I think it is a good way to let the free market decide how much of a free market we need in the financial sector.

Sarah Palin's pregnant daughter

There was an interesting discussion on the Footy show this morning about Sarah Palin's pregnant daughter. Footy is a moderate realist with a pretty good way of taking politics out of the discussion (unlike most of talk radio). So he asked: "whatever your politics, does it show failure as a parent if your unmarried, underage daughter gets pregnant?"

But I want to back it up one step and use the concept of behavior-based safety. I don't think the pregnancy is what matters. After all, condoms fail. Even a responsible 17 year old can get pregnant (unless they practice complete abstinence). If the parent did a responsible job teaching the child (son or daughter) about safe sex, STDs, etc., then he or she is a responsible parent. Sometimes, even responsible behavior results in unfortunate "accidents."

So I would only blame VP-nominee Palin for the pregnancy if she was irresponsible in what she taught her daughte, not for the pregnancy itself.

This could be a national "teachable moment" if she used the abstinence only approach (which I would guess given her evangelical status). If even a well-educated, stable, strong-values family can fail using abstinence only, I think this is a good lesson to advocates of it.

Mattel v Bratz

Mattel is suing the maker of Brats (AMG) for violation of its Intellectual Property. Apparently, the guy who came up with the idea for Brats was working for Mattel at the time. So any IP that he came up with is the property of Mattel.

AMG is countering that they did most of the work and took all of the risk. They finalized the design, figured out how to manufacture the dolls, marketed the brand, invested in the inventory, etc.

Legally, AMG's argument is full of holes. IP law gives Mattel the right to prevent anyone from using the IP. But we can debate two implications.

First, should IP law have this result? AMG did put a lot of time, money, and their own IP into developing the Brats brand. Should this give them some kind of rights? The original idea of IP law is to promote the progress of science and the arts. What stance achieves this the best?

Second, what should the damages be? Should Mattel be able to recover all of the profits AMG shifted from Barbie (made by Mattel) to Brats? Or should the investments AMG made in developing Brats be give some kind of credit? The current law and precedent probably finds in favor of Mattel. But again, what SHOULD it be?

Free Speech online

I am a very strong believer in free speech, so I was torn after reading last week's business article on Juicycampus.com. If someone calls me a schmuck in public, I can either call them a name back or just let it slide. Or if it something specific, I can refute it. If I am not present, I can refute it later. And anyone listening can consider the source of the information to determine its credibility.

But online, things do get a little different. When something bad is said anonymously on a site like Juicycampus, there is no closing of the loop. The comment is anonymous so readers can't judge the source. Second, it is permanent so the damage lasts longer than live speech. And third, if someone Google's the person's name, they may get the comment out of context and not be able to judge its veracity or the reliability of the source.

I don't think we want to go to the extreme of holding a web site liable for what is posted. That would be too much an impediment to the development of active communities. And there are good business models that run on anonymity, especially with respect to reputation management.

And if we allow governments to subpoena the poster's identity, it eliminates the most important aspect of free speech - the ability to speak out against the government. Law enforcement access, even if a judicial warrant is required, is too potentially intimidating. Think of China or Burma.

So where is the balance? If we don't want to allow people to post anything, anywhere, completely anonymously (because then it becomes impossible to prosecute slander and libel), and we don't want to impede sites that allow anonymous postings, and we don't want to allow law enforcement to access anonymous posters' identities, then what?

My recommendation is that we just allow law enforcement to access the identity if there is probable cause of a crime (libel/slander), but not for anything else. And no fishing expeditions like the recording industry was able to get to track music file sharing. The standard of evidence needs to be strong enough to keep the Internet basically free.

Making government documents understandable

((Cross posted from my human factors blog))

Well, its not the law yet, but the House of Representatives passed the Plain Language in Government Communications Act of 2008. Now we just need the Senate at GW to join up.

The basic idea is that all government documents will now include "language that the intended audience can readily understand and use because it is clear, concise, well-organized, and follows other best practices of plain language writing". Sounds like usability to me (and to Caroline Jarrett at Usability News - thanks for the pointer).

This is only half the battle too. Its one thing for the government to promise to make its documents user friendly. The next step is to require other people to make their contracts easy to understand and use (see my book chapter on how to do this). The lack of readable contracts is part of what got us into the credit card mess, subprime mortgage mess, health care insurance mess, and many others. We wouldn't need half as many lawyers if contracts were understandable. But of course, lawyers write the contracts, so . . . .

And for anyone who thinks that regulating contract language is anti-free market, think again. This is a strong libertarian idea. If companies had to make their contracts understandable to their intended customers, those customers could be freed to sign up for any kind of contract they want (except for the universal taboos like slavery etc). They would know what they are getting themselves into and be "allowed" to make that choice.

The reason we need regulation that actually limits behavior is because customers don't/can't understand the fine print. So we have to prevent companies from putting nasty stuff in that fine print. But if the customer understands all of the details and still wants to enter into the agreement, why not let them? This only works when we have understandability.

This new Act is a good first step. Go Congress Go !!!