Any serious attempt at financial reform has to grapple with three laws that Congress cannot repeal or amend:
1. Gresham’s Law. Centuries ago, Gresham observed that bad money drives out good. He was commenting on currency debasement, but his principle applies to many other human endeavors. For instance, banks that aggressively exploited regulatory capital rules had lower capital costs, and could, and did, use their lower capital costs to drive out competitors who were not as aggressive. Bad banks drove out the good. This perverse result is more common than most would think; regulations designed to thwart bad conduct end up encouraging it. This seems to be an unavoidable failing of any top-down, one-size-fits-all regulatory structure.
2. Prince’s Law. Just before the bubble burst, former Citigroup CEO Charles Prince memorably observed, “As long as the music playing, you’ve got to get up and dance. We’re still dancing.” Prince was widely criticized for saying this, but I wonder how many of his critics could have, in the midst of one of the greatest credit expansions in history, shut down lending, closed departments, fired employees and put a “gone fishin’” sign on the window. Inertia is one of the most powerful forces in the universe, stoppable only by an equal and opposite force. Too often the equal and opposite force that stops the dancing also crushes the dancers.
3. Summers’ Law. Larry Summers once wrote a paper criticizing the efficient market hypothesis. Its first lines were: “THERE ARE IDIOTS. Look around.” I start by looking in the mirror. When we try to fix past problems with new regulatory structures that depend, at their center, on the wisdom of regulators, I have to wonder why we think this time it will be different. We seem to think there “were” idiots, when in fact there “are” idiots, something we will prove again, and again, as much to our regret we learn, and re-learn the essential truth in Summers’ Law.