Paul Krugman writes an Op-Ed on where the political debate is at and I agree with most of his points. Of particular importance is this one:
So what the legislation needs are explicit rules, rules that would force action even by regulators who don’t especially want to do their jobs. There should, for example, be a preset maximum level of allowable leverage – the financial reform that has already passed the House sets this at 15 to 1, and the Senate should follow suit.
I favor this but I nonetheless think it remains problematic. The more binding the leverage restrictions, the more banks and other intermediaries may try to recreate implicit leverage off the balance sheet. (This is one reason to push for decentralized market monitoring, though I am not suggesting exclusive reliance on that.) It's fine to call for maximum transparency, but mostly that's just wishing for a different world. Activities off the balance sheet are off the balance sheet for a reason and it is hard to squeeze many of them into traditional accounting conventions. Nor should we try to ban off-balance sheet banking, as it would happen somewhere — both geographically and in some corner of the financial sector – and indeed many of these transactions limit rather than raise risk.
The upshot is that managing off-balance sheet risk requires an ongoing, hammer and tongs approach. There isn't any "once and for all" solution to banking regulation and the harder we try to find one probably the more we will end up relying on regulator discretion and judgment.
Bank regulation is a tough slog, it depends on the quality of the bureaucracy and the periodic attention of a somewhat responsible legislature, "toughness" can be counterproductive, the historic periodic of regulatory "easiness" relied on cartelization and near-automatic profits, and it is like a chess game whereby the private sector eventually finds a way around most of the binding regulations.
And now we can return to why financial reform is hard to blog. There's always a new proposal and a big tizzy over the particular contents of that reform. Whatever one thinks of the specific suggestions, I keep returning to the notion that the quality of the regulators — most of all Congress — truly matters.
How many times can one say that? How many times can one think that and run away in fear?
Arnold Kling has good remarks on transparency.