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.


> 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?

"a crisis is a terrible thing to waste"

True. Depressing.

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.

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.

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."

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.

The key would be to create some form of personal liability for regulators.

I like the European take, which makes me wonder, where did all that PMI go? Is it in the lock box?

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.

"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.

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.

I think only part of the problem (and therefore) the solution is the absence of an effective regulator. There is another problem which is the absence of an effective facilitator.

The financial markets have become increasingly interlinked. Banks are both risk-takers and deposit takers. Insurance companies both insure against risk and make investments themselves. And then there is the cross-border investment issue. In such a world, one of the problems that arises is that there is very little transparency in the dealings between various sub-components of the system. This is because every player is driven by their own self-interest and are trying to trying to maximize value for themselves, and therefore do not take a holistic view of systemic risk.

With this current crisis, a big part of the problem was that risk was unknown/ unacknowledged by the various players. This was on top of banks rushing headlong to take risks.

So more than a regulator that will say "You can do this and cannot do this", I think the need is for a facilitator that ensures standards and transparency of reporting for the various players. The facilitator would/ should push along dimensions such as having a clearing house, laying out disclosure standards, providing summary information to the various players, working aggressively to address areas of information asymmetry.

A information facilitator may end up being far more valuable than a more stringent rules setter.

One thing is crystal clear though†¦ the more consolidation the more risk of incest.

The bank regulations that came out from Basel and by which some regulators thought they could control for risks by inserting between the markets and the bank a block of arbitrary and outright silly capital requirements based on credit ratings, is more than enough evidence of how incest affects the brain.

A VOXEU column and an IMF working paper argues that Canadian banks have been more resilient because they rely on more stable retail deposits from households instead of short-term wholesale funding from interbank markets.
They also propose a Pigovian tax on short-term wholesale funding to get other banks to do the same.

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