What are your thoughts on regulating financial institutions going forward?
In a nutshell, anyone who borrows short and lends long and who offers safe assets for savers but invests in riskier products is a bank and needs to be regulated like a bank. Otherwise, our system remains prone to the catastrophic meltdown that we’re experiencing.
What made this crisis possible was that the banking system expanded beyond traditional banking, which was covered by the safety net built in the 1930s. The system of deposit insurance and regulated lending was undermined as banking activities expanded beyond regulatory control. So I believe we ought to be expanding old fashioned banking regulations to a much wider range of institutions and activities.
The ideal solution is to subject all such institutions to bank-type capital requirements. They should have a well-defined set of government guarantees that apply to a wide range of assets, financed through an equally well-defined set of premiums like those that banks currently pay into the FDIC, to help finance rescues when necessary. If you are a hedge fund, for example, you should be subject to the same kind of regulation and oversight as any other financial institution.
Depending on how it’s applied, an administration proposal which would allow the Fed to identify systemically important institutions and subject them to regulations, would pretty much do what I’m proposing. Take a business that sells auction-rate securities, something that technically does not involve bank deposits, but sure as hell functions like one. We’ll say that you will have capital and reserve requirements like an ordinary commercial bank because for all practical purposes, you’re doing the same thing.
Key to all of this is codifying principles-based, not rules-based, policy. This would more likely inhibit the financial industry, with their very good lawyers, to find ways to evade legislative intent.
This is an interesting take. Let me know your thoughts.
Grace & Peace
PLW
I generally like Dr. Krugman's ideas. Not in this case, at least not as expressed.
ReplyDeleteBanks WERE REGULATED. They failed anyway (if not literally, at least to the extent they needed a massive capital injection from the government to save them).
That was mostly a problem with UNDERWRITING. You know, lending to groups of boy scouts who thought sailing icebergs to Saudi Arabia in July to make sno-cones was a good idea.
And now for that cup of coffee...