The New Regime

Initial ideas about the new financial regulatory regime are getting floated in the press. Perhaps not surprisingly, a lot of the material seems similar to the Group of 30 recommendations.

This all sounds pretty good to me. My main comment, though, would be that we shouldn’t put too much confidence in any regulatory regime. One of the things we’ve seen recently, I think, is that there’s a bit of a paradox around these kind of regulations. If they have any teeth, then there’ll be people who stand to make money from relaxing them or from finding and exploiting loophopes. And if they work, then for a long time there won’t be any major problems. And if you go for a long time without major problems, people are bound to get complacent and start not caring that loopholes are being exploiting. Indeed, they’ll start seeing the loopholes as a reason to relax the regulations. And then eventually you get a blow-up and a renewed interest in regulation.

Long story short, one of the big things we were missing heading into this crisis was not just prophylactic regulation but any clear guidelines for what happens if things go bust. One of the main virtues of the FDIC process is simply that it’s a well-understood crisis. FDIC regulations don’t always work, but bank failures on an FDIC level don’t lead to “bank panics” anymore because everyone understands that the FDIC has a process in place and is comfortable for letting it unfold. We need, I think, some more general prescription for what’s supposed to be in the box if the Fed Chairman or Treasury Secretary needs to reach behind the “break glass in case of emergency” barrier.