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Why take the chance?

Mike Konczal weighs in with an example of why we should be cautious about entrusting the capital requirements in financial regulation to regulators:

People talk a lot about the “unregulated” shadow banking market, but it is important to remember that they were (poorly) regulated by the SEC. And the SEC gave an exemption to 5 firms – Goldman, Merrill, Lehman, Bear Stearns, and Morgan Stanley – to leverage up further in the 20-40 to 1 range, while commercial banks were still leveraged in the 8-12 to 1 range. The more leverage means the bigger the returns, but the harder the falls. This increased the regulatory arbitrage of the shadow banks, because these five firms could act as if they were commercial banks but could be significantly more leveraged, offering better deals and crowding out the market.

There is nothing in the Dodd Bill that would have stopped this other than the hope that regulators at the Federal Reserve are smarter, more resistant to lobbying, and will let their actions be more transparently monitored, critiqued and subject to democratic review by the public and the general community of investors than the SEC. Maybe this is true today, and maybe this is even true on a medium term time frame. By why take the chance, when we can simply put in a hard line of 15-to-1 like in the Frank Bill?

The definition of insanity, they say, is doing the same thing twice and expecting a different result. Well, this isn't quite the same thing. But it's close enough to at least qualify as an "absurdity." Indeed, if you just told someone the basic facts of the case -- "we had a huge financial crisis abetted by lax and captured regulators and we're going to try to prevent the next one by giving those regulators way more power" -- they'd think it pretty weird.

By Ezra Klein  |  March 29, 2010; 4:31 PM ET
Categories:  Financial Regulation  
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Whoa, traveling to the future to post your blog entry...

Posted by: imherefortheezra | March 29, 2010 4:21 PM | Report abuse

Also: see the Frontline special, "Warning," which documents efforts to restrict oversight of derivatives markets:

Posted by: y2josh_us | March 29, 2010 4:38 PM | Report abuse

The fed isn't really know for process transparency. In fact, just the opposite. To maximize the effectiveness of rate changes they are deliberately and rightfully opaque in their processes. This fact seems to militate against making the Fed the regulator. If they have one institutional mandate that demands opacity and another than demands transparency, they're likely to fail at both.

Posted by: zosima | March 29, 2010 6:03 PM | Report abuse

I'm going to echo a commenter from a previous post who said something along the lines of 'take away regulators' discretion'. Capital requirements are laid in stone requirements.

Posted by: justin84 | March 29, 2010 7:17 PM | Report abuse

Sent that too soon. Last sentence should read "Capital requirements are laid in stone as actual requirements - not suggestions for regulators to consider nudging the banks towards."

Posted by: justin84 | March 29, 2010 7:18 PM | Report abuse

Apologies if I'm missing the obvious, but while I know that Greenwich CT is full of bankers who commute to Wall Street, why is he rolling over for them now that he's retiring? Is he looking for his golden parachute as a banking lobbyist? Is it as simple as that?

Posted by: CatfishHunter | March 29, 2010 9:56 PM | Report abuse

If you can solve the capture problem, you are in the wrong field.

Posted by: kingstu01 | March 31, 2010 7:41 PM | Report abuse

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