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program was complete by 1999, when the Glass-Steagall Act, separating investment and commercial banking, was repealed.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

[randy]

I remember 20 years ago people were enamorred with the thought of becoming a millionaire.I have seen large corporations that have created jobs to make more goods and ceo's and upper management become billionaires and multimillionaires that have the ability to walk away from jobs with multi million dollar golden parachutes.My question is energy prices have risen to ridiculuos rates the cost of housing has dramtically increased over the years(until recently that is)cars cost more,gas used to be ridiculously higher unil the tailend of last year.But wages have been stagnant for the average working man.My company just started implementing a 3% increase last year but we have raised our flat rate service price by 10% bi annually for the past 3 years.The only reason I've received raises was because I went in and asked for or demanded them.While most of my co workers haven't.The whole thing I'm getting at is that the rich are getting filthy rich but the average joe who helps them to obtain their wealth are treated like they should be happy to have a job.Everything goes up in this world but a blue collar workers wages.The only companies that have given decent raises profit sharing and cola raises were the automotive industry when it comes down to blue collar workers and their in the worst shape of all of us.Why have board members owners and upper management been able to become so wealthy that they will never be able to spend what they have and the working man is the one losing his house job and car.Greed is the root of all of our countries problems.The poor want to live above their means and the rich want to make as much money as they can without thought of the people who make their money for them.The funny thing is that when these multimillionaires made all this money it wasn't enough so they had to leverage their companies future by investing profits in stcks and bonds instead of saving them or they just gave themselves these outrageous bonuses so that the company didn't have a war chest to help and get them thru lean times.

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