Thoughts on re-regulation

How to regulate the financial system will be critical once we are past the crisis. One of the more thoughtful writings on the subect is by Clive Crook at The Atlantic. In Small World he makes a nuanced argument about the long-term war between financial regulation and financial regulation:

This decades-long compromise--an evolving and uneasy accommodation with the forces of financial innovation--has been smashed by the crash of 2008. But what comes next is far from obvious. The popular view that the current mess is all the fault of "deregulation" is misleading, at best. The implication that all we need do is return to an earlier era of stricter supervision is an illusion. To repeat, regulators did not choose to retreat; they were forced to. In the United States, Democratic administrations, rarely inclined to see deregulation as an end in itself, ceded at least as much ground as Republican ones. The main forces that spurred the retreat--the incentives to evade close supervision, and the technological opportunities to do so--continue to grow more powerful. So what do we do?

A new approach to financial regulation is already taking shape. The Treasury began to dissolve the distinction between banks and non-banks, for instance, when it widened access to emergency borrowing from the Federal Reserve--a privilege once held only by deposit-takers. Having extended the assistance they are willing to offer, the authorities must extend their supervision as well. The logic is the same as with deposit insurance: if you socialize the costs of failure, you have to regulate against recklessness. The broadening of intervention and supervision will need to go further.

There is much more to his argument. Check it out.

Boston University economists Christophe Chamley and Laurence Kotlikoff sent me this argument for a limited purpose bank. .

...Don't let banks take risky positions. Make banks stick to their two critical functions - mediating the payments system and connecting lenders to borrowers.

What will change this behavior is to not let it happen. Banks should be allowed to initiate only conforming, i.e., government-approved, AAA-rated mortgages and business loans. These would be long-term, fixed-rate loans with 20 percent-down and payments below 25 percent of income. The government, via the Federal Financial Authority (FFA), would use tax records to verify loan payment-to-income ratios. It would also spot check collateral. Once approved, the banks would bundle and sell "their" loans within mutual funds.....