Why the vanilla option is necessary

September 27, 2009

Welcome back Steve! That’s not me welcoming Steve Waldman back to the blogosphere, it’s me urging you to go and welcome him back by reading his latest blog entry, on the end of the vanilla option. It’s magnificent stuff:

Extracting the vanilla from the CFPA is not, as Felix Salmon put it “the beginning of the end of meaningful regulatory reform”. It is the end of the end. Vanilla products were the only part of the CFPA proposal that was likely to stay effective for more than a brief period, that would be resistant to the games banks play…

Rather than being anti-market, vanilla financial products would help correct very clear market failures that arise from imperfect information and high search costs. It is the status quo that is anti-market.

I’m sympathetic to the principled libertarian objection to having the government require private parties to offer a product they otherwise might not. No one should be forced to offer vanilla financial products. Small-enough-to-fail boutiques should be free to offer only the products they wish. However, if an institution wishes to avail itself of government-provided deposit insurance or to access Fed borrowing facilities, it is perfectly legitimate for the government to set requirements. The government can choose not to offer its safety net to institutions that don’t offer vanilla products, just as banks currently choose not to offer me a credit card unless I sign up to binding arbitration and unilateral contract changes. I fail to see why one is coercive and the other not.

As they say, go read the whole thing. And then call up Barney Frank and ask him to read it, too. It’s not too late for him to change his mind!

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