Some on the left seem somewhat disappointed in the administration’s regulatory reform proposals. I think that’s misguided, and it comes from probably expecting too much from prophylactic regulation. If you look back at the Clinton and Bush years, it’s simply not the case that we had a situation wherein executive branch policymakers were chomping at the bit to clamp down on financial malfeasance and were being held back by a lack of statutory regulatory authority. In part, we can question the judgment of the policymakers but we also need to recognize that it’s an inherently difficult situation. Our past two bubbles have brought extremely low unemployment, and created huge quantities of paper wealth that individuals became psychologically anchored to. You can give regulators all the statutory authority you like, and the fact remains that there’s bound to be enormous reluctance to actually pull the trigger. It’s always hard to get government to clamp down on activities that very rich and powerful people want to engage in. When you’re talking about doing so in a way that could also jeopardize the jobs and 401(k)s of a mass public, well, it’s very hard.
Under the circumstances, parking systemic risk authority at the quasi-insulated Fed seems like the right call. So that’s one important decision the administration got right—to not hubristically insist that they, themselves would be immune to the political factors that make it difficult to do this kind of thing correctly.
What’s more, their regulatory package is reasonably strong on two ideas that I think could work. On the one hand, they have this consumer protection business. That’s probably not essentially to preventing global financial panics, but it will help protect the interests of individuals who interact with the financial system. That’s important. It also continues to be somewhat unclear exactly how much of the bad lending activity was truly fraudulent, but it’s at least possible that stronger consumer protections will help keep things under control. Last and most important of all, I think, is the idea of creating a clear legal process for the “resolution” of large, complicated financial firms. This is the one aspect of the crisis where I think you really can say that policymakers did want to do something different and better than what they did (ad hoc bailouts and bankrupties) and really were restrained by a lack of statutory and regulatory authority. There’s a plausible story to be told in which the global financial panic was caused less by the collapse of the bubble per se than by the fact that the system had no real way to process the failure of certain kinds of firms. Resolution authority, if done well, could really make a huge difference in the future. In my opinion, that’s the most important piece of the puzzle, and I think it’s right of the administration to focus on getting that piece right rather than to expend energy fighting battles about the organization chart.
All told, I don’t think we should place enormous faith in the idea that any regulatory setup will work forever and ever. Under the circumstances, these proposals seem like a plausible improvement on the status quo and should also leave us in a much better situation to mop up a future mess if it arises.