Thursday, March 26, 2009

Banking Regulation

Today's installment of "Things Geithner does which are not helping" is this new financial regulation plan that targets the 'exotic' finance bits for new regulation.  

I'm a little ambivalent about this nearly universal trend to blame the (this really needs a better name) ongoing financial worries on poor or insufficient regulation.  One one hand--clearly more regulation could have helped.  Some combination of 1) Cheap credit 2) Low interest rates 3) Complex Securities 4) Asset bubbles 5) Too much leverage, etc. are behind this and every other financial panic which has hit somewhere in the world roughly every ten years, and these are all influenced by policy.  I don't think we're ever going to fully fix this--not even if we bring in the physicists or Roubini or whatever group "called" the crisis--so it's in some sense a tax we pay for living in a country more advanced as a capitalist economy than Burma. 

Still, it's a little worrisome that the top-of-the line Basel financial reforms were counter-productive, if anything, that the crisis has hit the most regulated parts of the financial sector--banks and housing--the worst, and that the potential regulators (President, Congress, Federal Reserve) were as gung-ho about housing as the private sector.  

It's also a little ironic that Geither thinks that these unregulated hedge funds represent such a large problem given that they are, you know, kind of key to his plan for bailing out the entire financial sector.  How good could the hedge funds be at this job if they had been subjected to this kind of scruitiny from the beginning?  Is there any problem here that needs fixing?

Then you can look at the failures of regulation over the past several years.  As someone said, financial regulation is a little like shooting a moving target--despite the various and sundry rules and regulations we had on the books, banks found ways to disregard them and do whatever it took to make them money.  Exisisting compensation plans actually incentivize people to think long-term quite a bit by making people hold stock for a long time.  The general pattern seems to be that after a crisis, regulators clamp down on whatever was directly responsible, then bankers figure out new and innovative ways to ruin the economy.  It's not like "regulation" is something that exists on an axis, and some sufficient amount of it can protect you against any problem--you genuinely need good regulation that works by setting broad principles and guidelines.  Now is probably not the best time to figure out what that means. 

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