And I Thought I Was a Pessimist

Part of my strategy in my first few articles on financial regulation ("Of Mises and Min(sky)" and the quite misleadingly titled "Don't Panic!") was to try to corner the market on pessimism.  Staying the course looks bleak given where that course has taken us.  Extensive new regulation will fail both because of the capture issues at issue in this forum as well as the sheer complexity and the bounded rationality of regulators.  Laissez-faire led to the Great Depression.

But I have clearly failed at cornering this market.  One of Erik's posts nicely summarizes the failings of most leading approaches.  Kim's attempt to summarize the first set of posts from yesterday has us waiting for Superwoman.  But it turns out that Superwoman cannot get confirmed in the U.S. Senate.

Up to now, I have more or less defended the Dodd-Frank Act as a way to muddle through with modest new rules that address the leading gaps we saw in the crisis.  Extensive delegation to regulators was needed given the obvious inadequacy of Congress (which, remember, is also subject to capture, and which for the most part doesn't have a clue what it's talking about).  Various strategies in the Act, discussed in my first post, try to keep the regulators awake and honest.

But maybe even that is just too much for this country's regulatory capacity.  Our financial markets are a vast mess, we have no tradition of grooming and valuing career regulators, and one of our two political parties is deeply allergic to the whole project.  Maybe a much more slimmed-down response to the crisis would have been better.

What might such a response look like?  I see two or three elements.  One is a resolution authority so the government can step in with failing financial companies, quickly dispose of their assets, and punish those in charge.  This is needed not just for the very biggest too-big-to-fail companies, but for much if not all of the shadow banking world--a series of failures of modest companies can be just as bad as the failure of one big company.  That's how we got into the Great Depression, after all.  A second element is a relatively simple set of capital and maybe liquidity requirements.  These again should apply to most or all shadow banks, though be stricter for the too-big-to fail institutions.  And some of the contrarian roles, especially the Office of Financial Research, would still be useful even within this stripped-down approach.  In sum, I'm suggesting Articles I and II of Dodd-Frank but expanded beyond just the biggest companies, and that's it.  That wouldn't be good enough to stop a future crisis, but then again, neither is what we've done.

So maybe the title for my next article will be something like "Never Mind:  Starting Again with Our (and My) Response to the Financial Crisis."

Comments

[Kim Krawiec]

Success at last! We've been trying to get you to empty the rest of that half-full glass since the signing, more or less. Only joking -- it can't be that bleak. But I agree with you that D-F should have tried to do less and do it better.

[Kim Krawiec]

oh and p.s. -- great title.

[Erik Gerding]

I usually don't like to wade into politics on the blog, but I think you hit a really important point, Brett, about the current ideological climate. Frankly, I don't recognize traditional Republican concerns about institutions in the current political dialogue. Threatening the Federal Reserve Chairman (who ain't no bleedin' heart)?

Moreover, the debate about public employee unions has the collateral effect of making the public sector look a lot less like an attractive (let alone a noble) calling.

[Erik Gerding]

Kim: If Dodd-Frank tried to do less, it would have been wittled down even further. I respect calls that Dodd-Frank should have been more carefully crafted, but there is the political reality of the issue attention cycle and the likelihood that more modesty would have meant the industry would be deeper into the "red zone" in the rollback fight now.

[Kim Krawiec]

Maybe you're right Erik. I just don't think that enough thought went into some of the provisions. My (perhaps naive) hope was that by focusing on the most serious issues exposed by the crisis, we could have had better legislation. But I take your point -- less for congress to focus on would also mean an ability of special interest groups to concentrate their efforts.

[Brett McDonnell]

My comment was intended to be somewhere in between Erik and Kim. I actually think that most of the Act is aimed at serious problems, and takes a plausible stab at addressing those problems. There are exceptions, but much less than one would expect under the circumstances. That is why I have so far largely defended Dodd-Frank. But my doubts are whether our agencies have the capacity to carry out all the new regulations and enforcement needed. Derivative exchanges are a worthy idea, but a lot of work. Ditto the Volcker Rule. Ditto the CFPB. Ditto new hedge fund rules. Ditto the 5% risk retention rule for asset-backed securities. All individually valuable, all plausible responses to the crisis, all ideas which agencies might be able to put into action on their own. I think that Congress dealt with each of these issues, and a number of others, roughly as well as it could. I just now wonder whether the whole is less than the sum of the parts, with so much going on that the agencies don't have the resources to implement any of these ideas well.