Re-Regulating the Banking Industry--Posner

Beginning in the 1970s, the banking industry was extensively deregulated. Other financial intermediaries, such as broker-dealers, hedge funds, and money-market funds, were permitted to offer close substitutes for services provided by commercial banks, and restrictions on banking were loosened so that the banks could fight back against their new competitors. The deregulation program was complete by 1999, when the Glass-Steagall Act, separating investment and commercial banking, was repealed. However, the Bush Administration, as part of its general free-market philosophy, instituted a regime of regulatory laxity that included bank and securities regulation. This laxity, along with the Federal Reserve's error in depressing interest rates in the early 2000s, contributed to precipitating the banking collapse and the ensuing depression in which we find ourselves. A natural response is to tighten up regulation. In the case of commercial banks, this would not require new legislation. The bank regulators have virtually plenary control over banks: thus the crack "what does a bank say when a regulator tells it to jump?" Answer: "How high"? Burned by the banking collapse and employed by an Administration less complacent about the self-correcting character of financial competition than the Bush Administration, current regulators will not allow banks to take risks though, paradoxically, may compel them to in order to increase the amount of money in circulation and thus stimulate economic activity. The banks, being undercapitalized, are afraid to make risky loans; they thus don't have to be prevented from taking them, at least in the near term. The current complaint about the banks is that they are hoarding cash--that they are excessively risk averse--and thus are failing to provide the credit that the economy needs in order to recover. To tighten regulation of banks at this point would thus not only be a case of closing the barn door after the horses have escaped, but also would undermine the government's policy of encouraging banks to lend. The most challenging issue of financial re-regulation is bringing the nonbank financial intermediaries under the regulatory umbrella, in order to prevent effective bank regulation from simply shifting ever more financial intermediation to firms not shackled by regulation. One can imagine imposing capital requirements, leverage limitations, or even reserve requirements, on nonbank financial intermediaries. But this would require an elaborate regulatory apparatus that would cost a lot and, more important, might be ineffectual because of the complexity of modern finance and the heterogeneity of the nonbank intermediaries. I would prefer to see, at least as an initial step, requiring greater regulation of specific financial instruments, in particular credit-default swaps, which are at present unregulated credit-insurance undertakings often with no backing in the form of either reserves or collateral. Financial intermediaries find themselves both issuers and purchasers of such swaps (that is, both insurers and insureds), and because the swaps are not traded on an exchange, are not standardized, and are not regulated to assure that the issuer can honor his undertaking, they have been a source of debilitating uncertainty in the present crisis. We would not be in the fix we're in were it not for the Federal Reserve's having pushed down interest rates too far and keeping them down too long, thereby setting the stage for a credit binge (including the housing bubble), and, relatedly, were it not for the very low personal savings rate of Americans and their investing almost their savings in risky assets such as houses and common stocks. The problem of excessive borrowing can be addressed both by the Federal Reserve, which exercises a high degree of control over interest rates, and by the government's placing limits on credit-card and mortgage debt, for example by repealing the deductibility of mortgage interest from taxable income. But the most important point I would make is that there should be no new regulatory measures until the depression reaches bottom and recovery begins (not that there can be certainty about when that point has been reached--there were several false bottoms in the 1930s depression). Any regulatory initiatives at this time will simply increase the already great uncertainty in which the financial industry is operating; and as Keynes pointed out, anything that increases uncertainty in a depression causes hoarding, which can in turn precipitate a deflation likely to deepen and protract an economic downturn.

Comments

[Dave]

How do issues of regulatory capture and arbitrage play into this? Surely those issues should be addressed with any new regulatory regime.

[none]

Where is the evidence that regulatory "laxity" contributed to the current situation? Just name some examples. And even if you can provide evidence, please demonstrate that the aggregate cost in "correcting" such "laxity" would not have exceeded the gains (presumably from preventing this depression). You cannot regulate away a bubble. Monetary policy is a different ballgame. But you cannot say that the boom that preceded this bust was a product of lax regulation. There is no evidence. Almost all of the institutions involved were in compliance with banking regulator standards and were meeting their SEC reporting requirements. (Indeed, almost all of the institutions were regulated in the first place -- perhaps the vote of confidence granted by regulators is another way the feds subsidize the capital costs for these firms.) Most of those banking and disclosure requirements are mandated by statute or regulation, and I challenge you to provide examples of when the Bush administration regulators scaled back any banking or securities regulations in any way sufficient to provide a plausible example of regulatory laxity contributing to the meltdown. If anything, the administrations unwillingness to bend on mark-to-market (in combination with regulatory, i.e. arbitrary, capital levels) exacerbated the problems. As for the old canard about the repeal of Glass-Steagel. To this point, the biggest failures have been less "integrated" institutions, such as Lehman, Bear, WaMu and IndyMac. Both stand-alone commercial banks and stand-alone investment banks can purchase a bunch of bad mortgage-backed assets. Anyone with an awareness of life before Gramm Leach Bliley should know that separating investment and commercial banking did not prevent commercial banks or savings institution from screwing up the left side of their balance sheets. Please point out what in particular about the universal banking model is so pernicious as to cause or contribute significantly to this situation. And regulating the CDS market ... well, I suppose the federal government obligated itself to regulate the market when it provided de facto insurance policies to those institutions that irresponsibly purchased insurance from AIG. (It's hilarious that everyone of these bailouts becomes a justification for regulating the industries in which the institution whose creditors were bailed out exists. Don't bail AIG's creditors out and next time they might be more careful about buying a bunch of credit insurance from a firm without the capacity to meet its obligations. Who knows, the creditors who create the demand for the insurance products might even ... set up a clearinghouse to rationalize the whole thing. But no need to do that when the government will make you whole. Seems like kind of an unnecessary expense.)

Here's a proposal for preventing bubbles: Make it extremely clear that the government will not provide ex ante or ex post insurance on any type of financial product AND cease the subsidization of any type of financial product or balance sheet. God only knows what kind of capital levels banks would have to keep to attract depositors and creditors in a world without de jure ex ante subsidized deposit insurance and de facto ex post subsidized deposit insurance.

The point: Posner gets it completely backwards: The problem was too much regulation and too much government subsidized capital (both ex ante de jure and, as we now see, ex post de facto). Regulatory regimes provided a false sense of security, as they inevitably do. And, also inevitably, the awareness that government would never let certain huge firms fail promoted what would have otherwise been excessive risk taking.

[Uzair Kayani]

This is an excellent post. I worry, though, that the same kind of heterogeneity that makes a "bank by any other name" difficult to monitor will show up in investment instruments. There is too much sheep's clothing about. Two alternative fixes might work:

(1) A stronger substance-over-form doctrine coupled with punitive damages could help with the cat and mouse game. The detection problem is similar to what we face with conspiracies, crimes against children, or Sherman Act cases; these involve high penalties or low evidentiary thresholds, in part to compensate for under-detection.

(2) A regulatory focus on the underlying assets rather than instruments or intermediaries might help too. Bubbles usually occur in fixed-supply assets, such as paintings, land, houses, or stocks. A higher demand for these goods does not lead to greater supply; the supply curve is roughly vertical. These types of assets are easily identified. We could simply make a list of "bubbly assets" and regulate any money that touches them.

[neilehat]

none, Your rant reminds me of the disembodied voice exhorting the Lemmings to jump off the cliff. Clearly, given the economic temper, there is a problem someplace... It's all about perception, not withstanding the Markets "ability or inabillity to right itself". As for strengthing perception and confidence, Increased and better regulation is the first step. You see, it's really all about Social Psychology.

This is where the "Free Marketers" fail.

[none]

Neilehat -

Your dismissing my post as a rant and then not providing any substantive response (for instance, specific examples of lax Bush administration regulation sufficient to explain the crisis) further convinces me that I'm correct.

Yet, I get your point, and I think there is validity to the idea that a lack of confidence is a big part of this problem. Accordingly, you may be correct that the "perception" of better regulation will make people confident again. But it will only be a "perception." We've had significant securities and banking regulation since 1933 and still had a number of crises, several quite severe. If you're correct that government should find a way to convince people that everything will be ok going forward, you should also concede that (1) government will be conspiring in a con game with the regulated institutions and (2) the regulation won't work (because it hasn't in the past -- see now). As though the next time a massive hurricane and flood hits a major city the federal government will be proficient at evacuating individual homes. It won't be, and yet people like you think it's a good idea to tell all the people living in New Orleans and elsewhere that, next time, the feds will get it right, so sleep tight.

[Uzair Kayani]

It is true that the Glass-Steagall Act was denounced for a half century, and its repeal in 1999 was welcomed. U.S. financial institutions had complained that they were unable to compete with "universal banks" from abroad, and the Financial Services Modernization Act was meant to make them competitive by allowing commercial and investment banks to merge etc. Note three caveats, though:

(1) Glass-Steagall was already dead a decade before it was repealed. First, the Fed issued regulations that allowed commercial banks to invest in securities with up to 25 percent of their capital. This meant that commercial banks could invest in securities.

Second, investment intermediaries created money market accounts that operated just like bank accounts, but offered higher interest rates than the banks could, since bank interest rates were regulated.

So investment professionals were operating as deposit banks and deposit banks were investing in securities, Glass-Steagall notwithstanding. Insofar as Glass-Steagall meant to separate investment banks from commercial banks, it failed.

The value of the separation was probably that investors could tell the difference between money market accounts with higher risk and bank deposits with lower risk more easily, so that they were not fooled into thinking there was a free lunch involved. The more recent "enhanced cash management accounts" etc appear to have fooled investors in ways that Glass-Steagall sought to prevent.

(2) A second argument for Glass-Steagall was that it kept financial institutions smaller, and therefore avoided the "too big to fail" nonsense that has followed us since the Savings and Loans crisis, or at least Long Term Capital Management. The idea here is that it was precisely the Glass-Steagall repeal and subsequent bank consolidation (for example, Citigroup) that gave us the behemoths we see today. These behemoths have (a) lower costs of borrowing from the Fed and other banks, (b) explicit safety nets from the FDIC, Fannie, and Freddie; and (c) an implicit safety net from the taxpayers because of their raw "too-bigness." These multiple safety nets, coupled with low interest rates, allowed banks to lend and invest recklessly.

(3) The final argument for Glass-Steagall was that it could reduce conflicts of interest. We did not want a few players to wear too many hats, where the same holding company had subsidiaries making loans to a client, underwriting its stock, and holding its bank deposits etc. Conflicts of interest have received considerable attention in the rating agencies context, but they probably also increased because of the bank consolidation that followed Glass-Stegall's repeal.

[Mark]

@none: Isn't the regulatory framework you describe precisely what was in place before the Great Depression and the various bank panics of the 19th century?

[Michael F. Martin]

in particular credit-default swaps, which are at present unregulated credit-insurance undertakings often with no backing in the form of either reserves or collateral.

Even when not on both sides of these contracts (which obviously raises all sorts of incentive problems), the underperformance of sold off loans is a measurable fact. Banks may have gotten bored with the service of monitoring debtors that used to be part of their work, but that didn't make it unnecessary.

http://online.wsj.com/article/SB122706760885340319.html?mod=todays_us_money_and_investing

[neilehat]

none, Perception is everything. By it's use and misapplication, white can be turned to black and black to white. As Franklin Roosevelt commented on the "Great" Depression (what we're confronted with, may be far worse, if we don't get things turned around rapidly) is, "We have nothing to Fear except the Fear itself".

As for Junior's Regulatory policy, I don't have to comment. Bernanke came out today and said, "Much more Regulation of the Banking Industry is required". And this is from the experts in control. There is nothing to debate.

[mccullough]

The mortgage debt limit is a good proposal that should be politically popular at this point.

Instituting a law/regulation to require 10% down on a house (which used to be the industry standard requirement) means everyone has some equity and also prevents rank speculation.

This could also be apply to car loans eventually as well.

The credit card debt seems harder to police. The gov't could tie it to credit scores, but it would put the Big Three consumer credit reporting agencies in the same position that Moody's was in (the Big Three are sort of there in a way now) as far as grade inflation.

[Jack]

None........ I too find it troubling that even after seeing this Mess that you don't see the need for regulation.

What we have here is a case of short term greed overwhelming long term prudence; something that shocked Gspan.

Consider, just as one example, that the three biggest bond raters (Moody's et al) clearly sold off reputations that took a century to build for short term gain.

As for the "need" to be huge and "integrated" I've seen little support for that view. Instead it seems that small local banks have done fairly well by "tending to the store". It appears that "integration" made it easier for those of a short horizon to gamble than would be the case were mortgage or other insurances sold at arm's length with the premiums closely related to the level of risk. Example? Would you, or Buffet "insure" the potential losses of a Lehman Bros that is margined 30:1?????

Your "cure" of "harsh punishment" seems lacking as well in light of what we've just seen as fast movers played loose beyond belief with their fiduciary responsibilities to both stockholders and the future of their companies. Your "cure" assumes the thieves actually cared about the future of their corporation, or even that of our nation and the world as they leveraged longer and longer in order to quickly cash in on their lucrative "bonuses".

Example? M-Lynch "officers" opting to deal themselves tremendous bonuses at an earlier than traditional date......... acting, of course on insider information that they would soon be bought out by BA. One you'll recall "worked" there less than a year, gleaned something on the order of $25 mill, and promptly resigned. It ISN'T as if THEY had any "skin in the game" as would the owners of a Mom and Pop biz.

You try to make a case for the expectation of government bail outs giving an incentive to operate recklessly. How so? If our slicksters are in the biz of rape and run, why do they care what sort of a mess they leave to others?

Are you aware that typical FDIC banks HAVE defined loan ratios that they are expected to adhere to in return for being allowed to lend ten times the capital they have and be backed by FDIC? While the "non-banks" do not?

You ask: "Please point out what in particular about the universal banking model is so pernicious as to cause or contribute significantly to this situation."

...................... That seems an easy one. Consider a small biz guy who is required to carry workmen's comp insurance. He goes to the market and shops, finding that the rate he pays is roughly equivalent to the expected risk in his business. He gets bigger and buy "his own" comp insurance company? Immediately he has an a (short run) incentive to lower his premium..............on the basis that "things have gone well so far" and hope!! If his "insurance company" eventually goes broke the profits from his unrealistic underwriting are IN his original small biz. Perhaps you can imagine how our Wharton grads can embellish similar schemes for short term, personal, gain at the risk of the company? As we have seen?

Finally? Any banking activity that relies on lending multiples of their assets, carries with it the potential of losses beyond their ability to cope. That's why we have both FDIC and federal guidelines.......... FDIC is the ultimate "re-insurer" and it is that assurance that one's deposits are safe that makes the system work. You can't be serious to think that a system of unregulated Lehman Bros' gunslingers would be a working system??

[keith]

We need regulation when people cannot protect themselves AND those they deal with can easily act opportunistically, AND the external harm from non-regulation or the external benefit from regulation is great. In banking, we gained a great benefit when taxpayers guaranteed deposits, but to protect the taxpayers we had to prevent the banks from assuming too much risk. For many decades that gave us a well-functioning and stable credit supply. The same considerations hold now for the shadow financial world. We gain greatly by having the govt act as underwriter of last resort, but to protect the govt we then need to limit risk. There are also other ways to regulate than creating rules for creditors. For instance, improvements in corporate governance would eliminate much of management's temptation to act opportunistically.

[Anonymous]

In re accounting rules:

Instead of giving companies the -option- to pick mark to market, cost, or some other value model, why not -require- them to do both? I the case of UBS, 60b in m2m assets could be carried (and levered) at 80b if they disclosed both methodologies. Let the stockholders place a market value on the difference.

[none]

That Bernanke, an leader of the institution that many think should be grown into a bigger regulatory force, favors greater regulation is meaningless. (This is another one of the weird ironies of the current response: we invest taxpayer money in the banks we blame for the crisis and we propose giving greater power to the regulators who we blame for the crisis.) John Mack, CEO of Morgan Stanley, also favors greater regulation of all financial institutions. Perhaps Bernanke seeks ... power. And Mack, now that his institution is subject to much regulation as a bank holding company, desires that his less-regulated competitors (think hedge funds) be burdened by the same type of regulations that will shackle Morgan Stanley -- and without access to the Fed's discount window.

I didn't say that I did not see the need for any regulation. For instance, if deposits were privately insured, then my guess is the insurer would establish all sorts of "regulatory" requirements for the institutions whose deposits it insured. (Believe it or not, the private market institutes all sorts of "regulations." Ever read the trust indenture for an issuance of corporate debt -- filled with capital requirements, leverage requirements, dividend requirements, etc.)

Jack's posting is very interesting because I think he makes a good faith effort to justify some of the previous efforts at regulations, but fails to see that those efforts were shams because, to a large extent, what was called regulation was really the granting of a monopoly to the federal government and certain "private" institutions.

Take, for instance, the ratings agencies. There are federal laws that require certain financial products to be rated by certain "approved" rating agencies in order for certain other regulated entities to own those financial products. Accordingly, "the three biggest bond raters" actually had government-protected monopolies. For instance, ask this question, Given their obvious failures over the last few years, why are those rating agencies still in business? The answer is government protection. The government never should have been in the business of endorsing certain rating agencies.

Jack also points out that smaller banks have performed better than the large universal banks. I think this is true, though I don't have the data to prove it. But the point only reinforces my point that the federal government should get out of the banking business. There are a series of federal laws, from the National Bank Act during the Civil War through the Glass-Steagall Act that pre-empt state law regarding banking. I see no reason why, say, Illinois should not be able to regulate its banks as it sees fit. The feds think otherwise. Nothing has created more systemic risk than the growth of national laws and regimes, at the expense of localized regulation.

As for complaints about short-termism ... I don't know what the best way to deal with this agency cost problem is, but I don't think it is a good approach to provide such managers with government guaranteed (and thus relatively cheap) capital, in the form of de jure deposit insurance and de facto debt insurance. Had investors and depositors not been convinced that the feds would never let them lose on their "investments" (and that is the way a deposit should be viewed, not just if it's over $250K) perhaps those investors would have been much more cautious about lending to what Jack thinks were a bunch of sharks.

As for Neile's additional comments on "perception" ... why not answer some of the questions I raised earlier? Are you comfortable with the government being a part of the confidence game that is raising capital? Because you think increased regulation is needed to instill confidence in investors, are you conceding that such regulation might not actually do what it purports to do, i.e. protect investors? As for the reference to FDR ... I'm not sure if that was an endorsement of FDR or not. If it was, then you should review your history. FDR's efforts to pull the country out of the great depression were a disaster, by any economic standards. He did use the depression to reshape America, and whether that was good is another debate, but his policies did not grow GDP and probably exacerbated unemployment.

Lastly, Mark asks if what I propose is the same as what was in place prior to the Great Depression. The answer is largely yes, though I would argue that I would repeal the National Bank Act which was enacted during the Lincoln administration. My point is that the Federal Reserve Act (of 1913) and the various federal securities and banking acts of the 20th century have NOT prevented bubbles, panics, recessions and depressions. Such acts, though, have cost lots of taxpayer money (and there are also immeasurable opportunity costs as these policies have excluded so many from entering the markets which they regulate) AND have made the government complicit in the bubbles and panics that occurred after the passage of such acts.

I don't deny that we've seen incredible economic growth since the passage of the New Deal and related legislation in the 60s. However, I would argue that such growth has been in spite of such policies, as opposed to because of such policies. We also experienced great growth in the last quarter of the 19th century and first quarter of the 20th century. Who knows what might have been.

[Jack]

None: Thanks for the response and you make some good points. The Mess is difficult to discuss as typically we're faced only with a few variables, "all other things being equal" while today there is such a splatter that there are few trustworthy "givens".

To FDIC or not? I think I got 5 calls about FDIC limits as the meltdown unfolded from friends. Before the Fed quickly raised the limits even small businesses that had payroll accounts exceeding the limits were considering splitting up their accounts. I doubt those "investing" in the bank would have been reassured by knowing their assets were backed by a Lehman's, Sachs or AIG....... and that now it will be 100 years before anyone fully trusts the private financial sector, if then.

There seems some common sense, or lack of common sense at work here. Consider; if you or I were playing the stock market with OUR funds, we'd be cautious in our use of margin for knowing what could happen if we're wrong.

By contrast we had slicksters margined at 30: 1 using other folk's hard-earneds for their gain. Do they even care whether the gutted remnants of Sachs goes belly or is bailed out by taxpayers once they've departed bonuses in hand?

I conclude that along with the government bank charter allowing a company to leverage assets at 10:1 comes the obligation to insure depositor's funds (which puts the government at risk) and hew to certain guidelines. I don't think such a system can be recreated in the private sector.

[Disappointed]

I love reading this blog, but I was incredibly disappointed by Judge Posner's post. I don't discount the possibility that lax regulation contributed to the crisis, but "None" is right that such claims should not be thrown out without at least some support. In any public debate, there is the risk of demogoguery inferring causes that are convenient rather than correct. By assuming away the answer the question, Judge Posner encourages such demogoguery, though I know that was not his intent.

Posner also assumes that the Fed's lax monetary policy led to low long-term mortgage rates, a point Greenspan has refuted. I don't claim to know the answer to that question, but I don't think the assumption is as obvious as Judge Posner apparently believes.

This is a blog, so I want to be careful not to "demand" (as if anyone actually exerted control) on those posting discussion points. But in a complicated morass such as this, I would expect a little more attention to such a fundamental point.

[Sam]

If only regulations were the problem. Posner mentioned that the Fed kept interest rates low during the early 2000's, but this was a totally political decision. As has happened repeatedly throughout the 20th century, when a president of either party is confronted with the choice of:
(1) Losing an election because of a weak economy.
(2) Forcing the Fed to inflate the dollar for some temporary Keynesian-style stimulus.
The President will always choose #2.

[Uzair Kayani]

My understanding is that Mr. Greenspan's decisions are responsible for much of our troubles. You can tell because he vacillates too much nowadays. The weight of reputation makes fools out of reasonable men.

In the Journal piece, Greenspan argues that people's savings went up around the world because central planning gave way to the free market. Since people were saving more, they had more money to lend and invest with, either directly or (usually) through banks and intermediaries. So the supply of credit increased because of greater savings rather than low federal funds rates.

Note, however, that this does not explain why people's savings ended up in mortgage backed securities that blew up, rather than in other assets. It also does not explain why the real federal funds rate was negative when the housing bubble picked up speed- the so-called "Greenspan put."

It is unsurprising that 20 years and counting of Greenspan-like puts should create a permanent moral hazard in the financial services industry.

Mr. Greenspan also notes that mortgage rates did not move in lockstep with the federal funds rate anymore, and that this worried him. Here is his quote: "The Federal Reserve became acutely aware of the disconnect between monetary policy and mortgage rates when the latter failed to respond as expected to the Fed tightening in mid-2004."

Why, then, was he recommending that people take out more mortgages in 2004? See the link below:

http://www.usatoday.com/money/economy/fed/2004-02-23-greenspan-debt_x.htm

Finally, on regulating intermediaries, Greenspan writes that "the appropriate policy response is not to bridle financial intermediation with heavy regulation. That would stifle important advances in finance that enhance standards of living."

He felt differently in 2007, when things did not look quite so bad. At that time he explained:

"While I was aware a lot of these [dubious lending] practices were going on, I had no notion of how significant they had become until very late. I didn't really get it until very late in 2005 and 2006. . . . It's nothing to look in to particularly because we knew there was a number of such practices going on, but it's very difficult for banking regulators to deal with that."

See the following link:

http://www.cbsnews.com/stories/2007/09/13/60minutes/main3257567.shtml

So, briefly in 2007, Mr. Greenspan felt that some lending practices were bad but that they could not be controlled. Since that time, the "could not regulate" has reverted to a "should not regulate." I think his timing is backward here, in that the "should not" would have sounded better in '07 and the "could not" is more palatable now.

But timing is not his forte.

[Jack]

Disappointed: Couple of points:

First The Fed has very little control over mortgage rates as mortgages are sold on as bonds on an "open market" where rates are not set by the Fed. In fact if the Fed were "lax" and "printed too much money" it would create an inflationary expectation that would cause those buying mortgaged backed securities to expect higher returns, not lower.

As Gspans comments above imply our Fed may not have much of any control over the enormous international capital flows........ example, "non-banks" selling billions of their sliced and diced mortgage-backed securities all over the world.

Secondly, I do not agree that low mortgage rates are a problem. (Unless some artificial mechanism created a zero rate) Were normal mortgages made under NORMAL guidelines to consumers by normal banks using normal 10:1 ratios our financial sector could have easily weathered a spate of overbuilding much of which is regional in nature even after our financial wizards went berserk in concert.

As for Gspn, with all the data the Fed has at hand, it is HARD to believe that these top bankers did not know how far the non-banks were leveraged. Yikes! 30:1? A brief summer squall is going to take out any institution that is so leveraged.

[neilehat]

none, FDR's comment was an example of the use of perception in the economic policy sphere. If you didn't see that - whoa! As for the "failure" of that Administraions policy, there is more to it than just the simple "failure". One also needs to understand various Supreme Court decisions that gutted that policy and made it ineffectual. Much like the policy you advocate.

As for my position on "Regulation" there is a "time and season for everything". Clearly, NOW, is the time and season for Requlation.

As for the superiority of local regulation over federal regulation, what do we do with the Commerce Clause of the U.S. Constitution? As for me, those questions concerning State's Rights, were put to rest at Appomattox and Goldsboro, some Supreme Court decisions, not withstanding.

[David Heigham]

Even Posner nods. The questions are:

Why regulate? Because you will have to clear up the mess if things come apart (and it will be worse if you do not pick up the pieces). So you had better give yourself a chance of preventing things from coming apart.
What to regulate? Everything where failure can make a mess big enough for you to have to clear it up.
Who to regulate? All parties clearly capable of making such a mess.
When to regulate? As soon as possible, to give yourself time to prevent.
How to regulate? Make sure that the regulated are paying a full price for the risks they incur; and for the risks that they impose on others. Only forbid, and always forbid, taking substatial risks for which that full price cannot be approximated objectively.
How to make sure the regulators stick to this boring knitting? Make regulators more like Judges, with People's Attorneys perpetually putting the case for recognising risks?

[Ivan]

"Why regulate? Because you will have to clear up the mess if things come apart (and it will be worse if you do not pick up the pieces). So you had better give yourself a chance of preventing things from coming apart."
Except when regulation was the culprit in the first place. I repeat None's chalange not answered thus far - when George W. Bush relaxed financial regulation? Please explain. At the contrary, he tightened it strongly. See Sarbanes-Oxley. What is the basis for Belief that whole bunch of new Sarbanes Oxly's will "prevent things from coming apart" in the future? Regulators will become smarter when granted with more power? I think you take too many thing for granted.

"How to regulate? Make sure that the regulated are paying a full price for the risks they incur; and for the risks that they impose on others."

For the first part, you don't need any "regulation" in the sense of government meddling and coercive interference in the market - you just need to enforce the contracts and rule of law. If private firm went bankrupt, let it bankrupt. Do not try to "improve" the rule of law by coercive and corrupt schemes as bailouts and subsidies, as the now is the case.

For the second part, apart from being contradicctory to the first, the only way you can prevent big firm to exert influence on the others is to nationalize it completelly. Then, it cannot fail even in legal terms. But, the obvious price for that is taxpayers being forced to cover loses of the firm. Is that any better?

"When to regulate? As soon as possible, to give yourself time to prevent."

Sorry, but I must repeat that this is only religious Belief, not plausible assumption. Did regualtors prevented any crisis thus far? They had any legal authority to do that now. Why they failed? Maybe because they are probably not any smarter than rest of us. Every regulatory overhaul justified by the need to prevent suh a things from happening in the future was response to previous crisis. People cannot predict the future, because their knowledge is very limited. (see Hayek) Every future regulatory overhaul will certainly follow the similar pattern - dealing with the problems that occured during the previous (this) crisis. When next crisis occur we shall face new problems, completely unanticipated by previous (one that you demand) regulatory change and we predictably shall face, from people like you, new calls to impose more "regulation" in order to prevent "such things" from happening again.

[Ivan]

"Why regulate? Because you will have to clear up the mess if things come apart (and it will be worse if you do not pick up the pieces). So you had better give yourself a chance of preventing things from coming apart."

Except when regulation was the culprit in the first place. I repeat None's chalange not answered thus far - when George W. Bush relaxed financial regulation? Please explain. At the contrary, he tightened it strongly. See Sarbanes-Oxley. What is the basis for Belief that whole bunch of new Sarbanes Oxly's will "prevent things from coming apart" in the future? Regulators will become smarter when granted with more power? I think you take too many thing for granted.

"How to regulate? Make sure that the regulated are paying a full price for the risks they incur; and for the risks that they impose on others."

For the first part, you don't need any "regulation" in the sense of government meddling and coercive interference in the market - you just need to enforce the contracts and rule of law. If private firm went bankrupt, let it bankrupt. Do not try to "improve" the rule of law by coercive and corrupt schemes as bailouts and subsidies, as the now is the case.

For the second part, apart from being contradicctory to the first, the only way you can prevent big firm to exert influence on the others is to nationalize it completelly. Then, it cannot fail even in legal terms. But, the obvious price for that is taxpayers being forced to cover loses of the firm. Is that any better?

"When to regulate? As soon as possible, to give yourself time to prevent."

Sorry, but I must repeat that this is only religious Belief, not plausible assumption. Did regualtors prevented any crisis thus far? They had any legal authority to do that now. Why they failed? Maybe because they are probably not any smarter than rest of us. Every regulatory overhaul justified by the need to prevent suh a things from happening in the future was response to previous crisis. People cannot predict the future, because their knowledge is very limited. (see Hayek) Every future regulatory overhaul will certainly follow the similar pattern - dealing with the problems that occured during the previous (this) crisis. When next crisis occur we shall face new problems, completely unanticipated by previous (one that you demand) regulatory change and we predictably shall face, from people like you, new calls to impose more "regulation" in order to prevent "such things" from happening again.

[cyc]

The rating firms fradulently put AAA on the senior tranches of sub-prime laden mortgage pools (to keep their line of revenue flowing from their i-bank customer), or they were negligent in their mortgage pool analysis. Either way, the customer-supplier relationship between the investment banks and the rating agencies is highly conflicted and needs to be looked at more carefully.

[Shane]

While I agree completely that the Federal Reserve's interest rate policy began the mess that we are currently in, in my opinion I have not heard any proposals for dealing with the matter that seem to adress the real problem that is being faced right now.

It does not seem to me that regulation (to much or to little) is as important at the moment as real property value. I think that all economic policy and spending right now should be aimed at a massive market manipulation to bolster the value of real property. Something like a massive eminent domain program designed to take a large amount of real property out of the market for a calculated period of time while providing financial windfalls to the owners which would hopefully be spent on more real property. This idea should work if done on a large enough scale. Much of our economy is still derived from capital secured by real property, and it is exactly this fact that, as real property values have depressed to the point that they no longer secure the debt, has made many of the so called "toxic" assets "toxic." If the value of real property is propped up, everything else fixes itself.