In today’s Washington Post, Treasury Secretary Tim Geithner and National Economic Council Director Larry Summers laid out the principles guiding the Obama administration’s plan for reforming financial regulation, which is supposed to be rolled out in full this week. “The goal,” Geithner and Summers wrote, “is to create a more stable regulatory regime that is flexible and effective; that is able to secure the benefits of financial innovation while guarding the system against its own excess. “
There has already been plenty of reaction to the piece, but I’ll turn it over to Simon Johnson, who takes on Geithner and Summers’ claim that “a few large institutions can put the entire system at risk,” so we need a systemic regulator:
You need to control the behavior of large institutions, more than a few of which got us into this mess. If you can’t come up with a proposal to prevent them from taking system-damaging risk (and there is nothing in today’s article about this), then break them up. The article mentions penalties for being large — higher capital and liquidity requirements for larger banks; we’ll see the details in/after Geithner’s speech tomorrow, but I am not holding my breath for anything meaningful.
Back in April, Nobel prize-winning economists Joseph Stiglitz and Robert Solow said that the “most disappointing” aspect of the administration’s regulation plan was that it didn’t fundamentally reorganize the way in which large financial firms operate, and I think that concern is still valid. It really depends on how stringent the capital and liquidity requirements end up being, but by counting too much on a systemic risk regulator and a new resolution authority (for taking apart large firms that go bust), the administration may not be doing enough to directly stop firms from becoming so large and interconnected that they threaten the system.
This is especially important since the plan seems to be leaning toward a “council” of regulators, loosely overseen by the Fed, that will monitor systemic risk. As Felix Salmon put it, “we need a powerful single regulator with teeth, not a council of bickering sub-regulators.” Indeed, we’ve already seen spats between the various agencies and their regulators, which, if they continue, will work to the advantage of the banks playing regulators off against each other.
I know it means stepping on the toes of some congressional committees and regulators themselves, but if the administration is serious about getting systemic risk under control, it needs to have both strict rules governing Wall Street and an enforcer that has enough power to ensure that the rules are followed. Hopefully, both of those will come to pass as the administration makes the extent of its plans clear.