Making Financial Reform Fool-Resistant

By PAUL KRUGMAN
NYT

The White House is confident that a financial regulatory reform bill will soon pass the Senate. I’m not so sure, given the opposition of Republican leaders to any real reform. But in any case, how good is the legislation on the table, the bill put together by Senator Chris Dodd of Connecticut?

Not good enough. It’s a good-faith effort to do what needs to be done, but it would create a system highly dependent on the wisdom and good intentions of government officials. And as the history of the last decade demonstrates, trusting in the quality of officials can be dangerous to the economy’s health.

Now, it’s impossible to devise a truly foolproof regulatory regime — anyone who believes otherwise is underestimating the power of foolishness. But you can try to create a system that’s relatively fool-resistant. Unfortunately, the Dodd bill doesn’t do that.

As I argued in my last column, while the problem of “too big to fail” has gotten most of the attention — and while big banks deserve all the opprobrium they’re getting — the core problem with our financial system isn’t the size of the largest financial institutions. It is, instead, the fact that the current system doesn’t limit risky behavior by “shadow banks,” institutions — like Lehman Brothers — that carry out banking functions, that are perfectly capable of creating a banking crisis, but, because they issue debt rather than taking deposits, face minimal oversight.

(More here.)

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