I'm tired of reading articles like this. If you're going to blame the current crisis on a lack of regulation, please tell me what SPECIFIC regulations you would implement, and explain how they would have helped us avoid the situation we're in.
I personally can't stand Paul Krugman. I know he's done good work in academia, but his op-eds push a liberal agenda regardless of the evidence in favor of it.
In this case, how would the federal regulators know how to price risk better than the owners of financial businesses? Krugman doesn't say. He posits that they have some magic knowledge by virtue of being government agents.
The truth is, there was a unprecedented bubble in real estate values and real estate related debt. No one knew how to price them correctly. For a regulator to attempt to do so would be like a regulator setting the right price for Yahoo in 1999.
Neither does Krugman mention past failed financial regulation. Canada had only a handful of bank failures in the 1930's, compared with thousands in the US. The reason was that banks in the United States were kept small by anti-branch banking laws designed to keep any one bank from having too much power. The larger banks of Canada survived, not so the banks of the US.
What assurance do we have that the current regulators will get it right? Many people in public life seem to be drawing bad lessons from the current crisis so far. I'm inclined to think that they won't get it right.
Consider the current regulation that exists over the housing market:
- Mortgage interest deduction: In other words, you don't get a tax break for buying a house, you get it for being in debt b/c you bought a house. Hmm.. what incentive does this create?
- One time capital gains tax exemption for the sale of a home: This encourages people to sell their home and then buy a more expensive home, even if a less expensive one would have sufficed.
- The implicit federal bailout of Fannie and Freddie: These companies underwrite a lot of the more risky mortgages and as long as there is an expectation that the government will bail them out, nobody looks too closely at their soundness.
These are the regulations that got us into trouble in the first place.
He's not advocating new regulations. The point of the article was that the Fed has knowingly allowed the shadow banking system to take over banks role in providing credit without requiring those organizations to bear the regulatory burdens of traditional banks.
The shadow banking system is exactly like the unregulated banks of the 1930s. And as we're now seeing, the result is another financial catastrophe.
So how do you want to regulate the "shadow banking system" and the world of derivatives? What kind of reserve requirements should there be for traditionally off-balance-sheet derivatives? What kind of reporting requirements? If I come up with a new kind of funding structure -- something like a CDO, a SIV, whatever -- do I need to explain everything to the Fed first before going ahead with it? Who gets regulated: just the large non-depository investment banks? Smaller derivatives dealers and hedge funds?
I'm definitely sympathetic to the idea that regulators were asleep at the wheel. I just haven't yet seen any regulatory proposals that, if implemented, could have prevented the current crisis.
