Where bank regulation is headed

By Felix Salmon
September 9, 2009
Taunter's idea of splitting the financial services industry into highly-regulated Boring and largely-unregulated Exciting parts, and making it very clear that the Exciting bits could never get bailed out by the federal government. I disagree however with this:

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I like Taunter’s idea of splitting the financial services industry into highly-regulated Boring and largely-unregulated Exciting parts, and making it very clear that the Exciting bits could never get bailed out by the federal government. I disagree however with this:

While I could easily be convinced to give Inside or Outside responsibilities to other agencies, the one agency that cannot get either responsibility is the Fed. Indeed, one of the main goals of reform should be to strip any sort of oversight responsibility from the Fed.

The big thing missing from Taunter’s utopia is any kind of macro-prudential regulation — which is exactly what the Fed is perfectly placed to do. You can’t regulate the financial system on a case-by-case, institution-by-institution basis: sometimes you need to look at the big picture — including keeping an eye on what all those Exciting companies are doing. Let’s have the Fed do that, at least.

Regulators should also be asking more questions of market participants — the kind of people who were first to realize that AIG was in trouble. Lloyd Blankfein is right about this:

We should get more questions from regulators like, “Where are standards slipping or policies being stretched? Where are pressures building up? And, where are you seeing concentrations in risk?”

It’s in everybody’s interest for banks to be very open about these things with their regulators. After all, as Jeff Cane points out, Goldman itself was essentially bailed out by the government: were it not for massive government intervention in the financial markets last year, Goldman would not exist today. At some point, banks don’t benefit when competitors fail: instead, they themselves get hit as well.

It’s also worth noting that Blankfein admits that the finance industry “let the growth and complexity in new instruments outstrip their economic and social utility as well as the operational capacity to manage them”; he also says that guaranteed bonuses “are bad for the long-term interests of our industry and the financial system”. There’s definitely a pretty large degree of consensus forming now, and Blankfein’s speech gives a good idea of where we’re probably headed. Nothing too radical — certainly nothing along Taunter’s lines — but it’s still better than nothing.

Comments
4 comments so far

Wouldn’t giving the Fed that kind of regulatory capacity just continue the slow-motion dismantling of the 1951 Accord? It would seem to violate the spirit of that agreement, even though technically the Accord was between the Fed and Treasury.

Posted by Mike | Report as abusive

That is the regulatory system we had, boring commercial banks and exciting investment banks. It doesn’t work when even the exciting ones become too big to fail.

Posted by Lord | Report as abusive

That macro view is the job of Treasury and Congress. And even if you believe that there needs to be a single-purpose agency charged with the task, by all means, don’t make it the same agency that defends the dollar.

This is from Arnold Kling on EconLog on February 9th:

“Taleb, like me, wants to get rid of risk-taking by banks, and leave non-insured institutions free to take whatever risks they want, as long as they are not creating risks for others. His solution is to nationalize banks. (me: why would this mean that they would not take risks? Suppose that Freddie Mac and Fannie Mae had been fully nationalized as of three years ago. Would they have taken more risk or less risk?)”

And my response:

“Although I’d like to nationalize a few banks in this mess, I agree with you. We don’t need to run them, especially if we have narrow/limited purpose banks. I didn’t like this idea at first, but if it allows the existence of risk-taking non-insured institutions, then I’d be for it.”

Maybe we didn’t use the correct hand gestures.

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