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Regulatory reform
We won't see so much of it for financial services. I know, I know, a crisis is a terrible thing to waste, etc., but here are a few simple points:
1. Getting current regulators to do a better job may be a better goal.
2. The consolidation behind the Department of Homeland Security has not been a smashing success. It's too easy for regulators to focus on formal goals of consolidation at the expense of substantive goals of mission. And the prevention of forum-shopping can be achieved without formal consolidation.
3. The major overseer probably would have to be the Federal Reserve and that would mean the long-run chances for restoring an independent central bank would be slim. The Fed as super-regulator would be more accountable to Congress than is desirable.
4. Many of the real regulatory problems are due to the preferences of Congressional committees and it is high time we admitted this. How about reforming them?
Today's regulatory structure is not what anyone would design from scratch. Still, I haven't seen strong arguments for a major reshuffling of the boxes. Most of the arguments assume that the box reshuffling is somehow associated with a major strengthening of political will and thus must be a good idea. I haven't seen a good analysis which holds the amount of political will constant and shows that a box reshuffling will bring major benefits. In my view box reshuffling may signal political will but it will not itself cause more political will, so we should be holding the political will variable constant when doing our normative analysis.
If there are two ideas I would like to see take root in regulatory reform for financial services, it is the following:
a. Do not trust the states with anything really important.
b. Do not trust international agreements with anything really important.
Posted by Tyler Cowen on June 11, 2009 at 12:43 PM in Economics | Permalink
Comments
> a. Do not trust the states with anything really important.
do you mean states as in california, kentucky, etc., or do you mean states as in federal governments?
Posted by: babar at Jun 11, 2009 12:58:32 PM
How about
C . Do not trust the Financial services companies with anything really important
Posted by: Rama at Jun 11, 2009 1:05:00 PM
"a crisis is a terrible thing to waste"
True. Depressing.
Posted by: Dirk at Jun 11, 2009 1:26:39 PM
The geniuses who innovated the way to the massive $7T wealth creating ponzi scheme have made it clear that it is totally unacceptable to give stockholders a non-binding vote on the compensation of the genius leaders who must earn more than the richly compensated geniuses who are able to sell junk bonds with junk bond interest rates and the security of AAA bonds and earn huge commissions.
Bernie Madoff is a genius, he just wasn't working for a too big to fail unregulated bank where his actions would have been legal.
Posted by: mulp at Jun 11, 2009 1:30:44 PM
Simply unifying CFTC and SEC would have avoided the quibbling over which should be in charge of single-stock futures. Where two entities are performing very similar activities with very fuzzy jurisdictional lines between them, I think it makes sense to merge them.
Perhaps some kind of financial regulator -- an OCC/FSLC/FDIC/Federal Reserve -- should be separate from the central bank, but -- this is a response to point 2 -- consolidation here really does solve some jurisdictional problems in and of itself, where simply imposing the mission from any pre-existing entity in a uniform way with clearer jurisdictional boundaries would be better than the confusion and operation at cross-purposes that currently exists.
But, yes, 4 is a big one. If I thought it had a good solution, or that it were exacerbated by reducing 6 agencies to 3, I would oppose that unification.
Posted by: dWj at Jun 11, 2009 1:30:49 PM
didn't the most unregulated financial institutions, e.g. those located on cayman islands, do better than the more regulated ones during the crisis?
I propose to add:
d. do not trust the federal government with anything really important either.
Posted by: xyz at Jun 11, 2009 1:32:53 PM
How about reforming Congressional committees? Is there any foreseeable way to do so? If memory serves 9/11 was supposed to "change everythng", the 9/11 commission recommended changes to the oversight committees, and nothing happened. FDA's money is still in the ag appropriation bill because FDA was originally part of USDA. If I recall, Newt did do a little restructuring after he came to power in 1995, but not much. Frankly I see no conceivable way in which Congress could restructure.
Posted by: Bill Harshaw at Jun 11, 2009 1:49:04 PM
Regarding the superior record of Cayman Island banks - if those banks had failed, the Mafia, drug dealers, etc. would have tracked down the bank officers.
How's about the Canadian banks - big banks, no failures. However the political culture is a bit difference. Canadians recognize the legitimacy of government and don't fight regulation tooth and nail with a slew of lobbyists.
Posted by: Samis at Jun 11, 2009 2:12:15 PM
Every time I read these kinds of articles - and the comments - I have to shift into 'doomer mode'. We truly are f**ked. Nobody knows how to do anything, everyone is on the take, the good men have only to do nothing and are ... etc.
Part of this is structural; our economies have yet to disappear down the rabbit hole to emerge in shambles on the other side. This process destroys vested interests, even as it destroys everything else. Right now, vested interests have too much to cling to.
The rabbit hole - or abyss, if you prefer - beckons and soon the nonsense part will be done with. If a crisis is too valuable an opportunity to waste, think of how many more opportunities lie in a calamity. There is somthing about fuel shortages, hyperinflation, currency collapses, blackouts and food riots that focus the mind.
The anti- doomer, Winston Churchill; "You can always count on Americans to do the right thing - after they've tried everything else."
Posted by: steve from virginia at Jun 11, 2009 2:22:04 PM
What about actual reforms? I agree that box shuffling (apart from the jurisdictional issues mentioned by the other commenter) is pointless in and of itself.
In terms of reforms, what I'd like to see are:
- Regulation of credit ratings firms to avoid what is essentially pay for ratings - can we encourage more competition here somehow? Maybe this is more of a market design problem.
- Lowering the limit on leverage. 'Nuf said.
- Requiring more disclosure on an ongoing basis for exotic securities portfolios.
- Also, could we prohibit financial services firms from off-balance-sheet vehicles?
For the mortgage market in particular, it seems that removing inducements to offer risky mortgages would be a good thing.
Posted by: Greg at Jun 11, 2009 2:29:16 PM
e) Do not trust anyone with anything important?
This crisis has shown us that we cannot trust the private finance industry to not screw up. You say we cannot trust the government or any international agreements. So that leaves who exactly?
Seems extremely pessimistic if you ask me.
Posted by: chai at Jun 11, 2009 3:10:12 PM
trust in the invisible hand.
Posted by: Will McBride at Jun 11, 2009 4:33:53 PM
The key would be to create some form of personal liability for regulators.
Posted by: JohnBailey at Jun 11, 2009 4:35:51 PM
Some thoughts from an European economist on this issue:
1. The US has a stunning amount of financial regulation and parts of the mortgage system strikes me as almost a planed economy when compared to many European mortgage systems I know. So A) the regulation didnt work well or even contributed to the problems and/or B) Regulation was not enforced.
My sense is that it was A) rather than B). US bureacracies are excellent at enforcing the laws' letter and incredible bad at interpreting its intent(and US law making is a truely stunningly bad proces when compared to my Northern European experience - take cash for clunkers, most European legislatures did that in a couple of weeks - Congress have now wasted 3 months and still counting).
2. The major core problem revealed by the crisis does not appear to me to be financial regulation, but rather the US bankruptcy code. The crisis is due to the surge in foreclosures and banks mortgage credit default models not working out to forecast this. Most of these models were in essence 2 trigger models: You were forecast to go into foreclosure when 1) You couldnt pay AND 2) You home equity was wiped out so that a normal sale couldnt address the problem. Turned out reality was a one trigger model: You only needed to have negative home equity. The non recourse nature of US mortgages combined with the first widespread fall in nominal home prices since WW2 made foreclosures go 10 times higher than in any previous recession/housing crash.
So a central problem is that the non-recourse loans are giving perverse incentives for home owners to tranfer losses to the (leveraged) banking system in the event of falling prices.
Apparently US politicians think the solution to that is loan mitigation and twisting the law even more against creditors to help debtors. That is surely going to help! The implication: The US mortgage system is now defunct and can only run on tax payer guarantee life support. Also Americans will pay much more for their mortgages in the future, because they implicitly pay for the high risk of default in the event of falling prices. Those who pay their mortgages on time end up paying for those who gamble on housing. Apparently that is the way Americans want it.
There is a need for a more simplified and improved mortgage system. It is pretty simple to create one now. Introduce a balance principle for the GSEs and make them specialized mortgage credit insurers (and not lobbying, semi public bureacratic behemots). For more on this, check out Alan Boyce's ideas here...(Alan is former head of funding at Countrywide and knows a lot about mortgage systems in the US and internationally)
http://www.realkreditraadet.dk/Admin/Public/DWSDownload.aspx?File=%2FFiles%2FFiler%2FAarsmoede%2F2009%2FPrinciple_of_Balance_Lending_a_Better_Approach_Boyce_april09.pdf
Posted by: Carsten Valgreen at Jun 11, 2009 4:49:19 PM
I like the European take, which makes me wonder, where did all that PMI go? Is it in the lock box?
Posted by: Andrew at Jun 11, 2009 5:14:29 PM
I agree with your two final pointers.
I don't share the pessimism on regulation. The regulators did just fine from WWII until the 80's. As long as we keep relevant businesses under the umbrella of regulation, it worked, didn't it? It was only when companies like AIG snuck out from under the umbrella.
I don't go as far as Krugman, but I do think banks are in many ways a special industry like utilities, they should be kept boring.
Posted by: Jordan Heim at Jun 11, 2009 5:19:39 PM
Very nice post, Tyler. I especially whole-heartedly second your recommendations. State regulation of securities is typically even more subject to interest group capture and populist impulses, and states are often revoltingly insistent on mandatory application of their state law even when both parties agree otherwise.
International regulation is also a poor idea, simply because there is no accountability. If it's everybody's fault, it's nobody's fault.
The Canada comments are silly-they outsourced their risk to the US, which the US was willing to accept for reasons not relating to Canadian willingness to export risk. The Caymans are part of the same regulatory arbitrage.
Posted by: Tom at Jun 11, 2009 5:25:51 PM
So why exactly is the nation the most trustworthy source of regulation on things important?
Posted by: Robin Hanson at Jun 11, 2009 9:31:44 PM
"How's about the Canadian banks - big banks, no failures. However the political culture is a bit difference. Canadians recognize the legitimacy of government and don't fight regulation tooth and nail with a slew of lobbyists." - Samis
Well canadian banks are FAR FAR FAR less regulated than US banks.
Posted by: Doc Merlin at Jun 12, 2009 4:20:09 AM
"How's about the Canadian banks - big banks, no failures. However the political culture is a bit difference. Canadians recognize the legitimacy of government and don't fight regulation tooth and nail with a slew of lobbyists." -samis
Thats wrong as Canadian banks are far less regulated than US banks.
Posted by: Doc Merlin at Jun 12, 2009 4:21:38 AM
It gives us much to think about. Very well-written!
Keep blogging!
This is Joshua from Israeli Uncensored News
Posted by: Joshua at Jun 12, 2009 6:44:11 AM
It gives us much to think about! Very well-written! Keep blogging!
This is Joshua from Israeli Uncensored News
Posted by: Joshua at Jun 12, 2009 6:46:41 AM
It gives us much to think about! Very well-written! Keep blogging!
This is Joshua from Israeli Uncensored News
Posted by: Joshua at Jun 12, 2009 6:47:33 AM
"So why exactly is the nation the most trustworthy source of regulation on things important?"
I would suppose because there aren't enough experts to divide by 50. However, it is experts with heads in the sky rather than boots on the ground that get us into a lot of these messes. It is individuals on an individual basis who resisted the hysteria from top to bottom that kept the situation from being worse.
Posted by: Andrew at Jun 12, 2009 6:59:35 AM
Additionally, by STARTING with regulation at the Federal level, you miss the experimentation on the state level and also ensure systemic problems are nation-wide.
Posted by: Andrew at Jun 12, 2009 7:05:04 AM
