Gorton: Real reform must be based on understanding

Hysteria, witch hunts, show trials and finger-pointing aren’t going to prevent the next financial crisis, says Yale economist Gary Gorton in a New York Times column October 8, 2009.

Americans tried that 100 years ago, too, when stock market scandals and bank panics plagued the nation.

But after decades of scandal and tumult, in the end the problem was fixed with deposit insurance and bank panics disappeared for 73 years.

From the Gorton column:

Without seeing the panic directly, it has been difficult to make sense of the events. Effects were mistaken for causes. Many “explanations” have been proposed, and many evildoers have been nominated. But, the noise level, the hysteria, the witch hunts, the show trials and the finger-pointing are not productive in terms of financial reform. Real reform must be based on understanding what happened.

From the founding of America until 1934, banking panics were almost regularly occurring events, and exactly the same kind of finger-pointing and blame games happened over and over again, then as now….

…it took about 100 years until society decided that it was best to put people in a position where they did not have to worry about their checking accounts; deposit insurance was enacted.

In the last 30 years or so, as the global economy has expanded, another banking system, which works almost the same way, has developed. … This market is the sale and repurchase (“repo”) market….

Repo is to a significant degree based on securitized bonds as collateral, a combination called “securitized banking.”..

Policy makers need to recognize that the securitized banking system is important for economic growth. It needs to be protected and its vulnerabilities need to be addressed. That sounds a lot like advice given in the aftermath of the Panic of 1837.