Austan Goolsbee, speaking in part on behalf of Barack Obama, says that since recent events have shown that the Fed may need to step in and rescue failing investment banks those banks should be regulated closely in much the way that commercial banks are. Greg Mankiw seems upset about this but he doesn’t mount much of an argument beyond the query “Here’s a question for Austan: Can an investment bank avoid such regulation if it promises never to use the discount window?”
My first read on this was that a “promise” would be no good. A bank can’t “promise” not to fail. Nor can a bank promise not to be bailed out if it does fail. A bailout, when justified, isn’t a favor you do for the bank. It’s something you do because it’s necessary to avoid larger negative consequences throughout the economy. So a promise to avoid the discount window would be valueless. But if the public is going to need to guarantee that financial institutions that grow “too big to fail” don’t fail, then the public is going to need to regulate those institutions. Mark Thoma and Brad DeLong say much the same thing, with some added professional economisting and the added insight that Ben Bernanke appears to be on the side of more regulation here.
Photo by Flickr user Epicharmus used under a Creative Commons license