In my opinion, Amar Bhidé is one of the most important economic thinkers of our time. Along with Edmund Phelps and Jim Manzi, I think of him as the most important of the contemporary Hayekians. I’ve praised Amar a number of times in this space and elsewhere, and I’m pleased to report that his forthcoming book on the financial sector, A Call for Judgment, is as brilliant as readers of his last book, The Venturesome Economy, have come to expect. Tim Lee has enthusiastically recommended “The Judgment Deficit,” an essay Amar just published in Harvard Business Review that summarizes his central arguments. Among other things, the essay offers a lucid, intelligent take on the origins of centralized management and the pathologies it introduces, including what Amar calls “mechanistic decision making.” The most pernicious example of mechanistic decision making for Amar has been the rise of “robotic finance”:

There is a categorical difference between the age-old securitization of debt by railroads and electric utilities and the newer securitization of mortgage and consumer loans. The issuance of railroad and utility bonds does not eliminate holistic, case-by-case judgment. Rather, a few underwriters and rating agencies play a pivotal role in making these judgments, usually after extensive dialogue with the borrowers. Furthermore, the economies of scale in the railroad or power plant being financed compensate for the concentration of decision-making power. When housing and auto loans are securitized, by contrast, the concentration is not accompanied by any detailed analysis of the ultimate borrowers’ circumstances. The supposed benefit of cookie-cutter credit decisions is the lower cost of automated lending. But low-cost lending to borrowers who can’t repay is no bargain for anyone. The mass production of consumer loans isn’t like the mass production of consumer goods. The long-term consequences of excessive lending can be disastrous for borrowers, creditors, and society at large.
As lawmakers and regulators respond to the financial crisis, they are not evaluating the practice of securitization thoughtfully, asking when and whether it beats traditional bank lending; they are merely striving to restore securitization to its precollapse levels. Yes, there are a few stabilizing improvements: New laws require banks to keep 5% of securitized sub-prime mortgages. Beleaguered credit rating agencies promise to improve their models and provide more transparency. But policy makers are ducking the question of whether loans made to home buyers and consumers based on computerized credit scores should be securitized and rated at all, given the absence of any firsthand scrutiny of the borrowers. [Emphasis added.]

My main concern is that the regulatory approach Amar favors might be too difficult to actually implement:

I propose that we reinstate old-fashioned banking, in which bankers know their borrowers. This could be accomplished by tightly limiting what banks can do: Specifically, they should do nothing besides make loans to individuals and nonfinancial businesses—after conducting boots-on-the-ground due diligence—and conduct simple hedging transactions. The standard for making a loan or hedge would simply be whether it could be monitored by bankers and examiners who don’t have PhDs in finance, and whether the risk is one that bankers would take if it were their own money—a “prudent lender” rule, in other words.
These rules would apply to any entity taking short-term deposits from the public, whether or not it was called a bank. All others—investment banks, hedge funds, trusts, and the like—could innovate and speculate to the utmost, free of additional oversight. But they would not be allowed to trade with or secure credit from regulated banks, except perhaps through loans collateralized by liquid, high-quality securities. No lending against or purchasing of collateralized debt obligations, and no financing of warehouses of loans awaiting securitization, for instance.

This is a very attractive model, and Amar elaborates on the idea in his book. Yet my guess is that increasing capital requirements might be the best we can do. Oliver Hart and Luigi Zingales offered a different take on financial reform that’s worth a look.