Economist of the day

Posted: 7 October 2015 in Uncategorized
Tags: , , , ,

Here’s Fred Mishkin [ht: ra], an economist at the Columbia Business School and star of Charles Ferguson’s Inside Job, on the possibility of preventing a rerun of the 2008 financial crisis:

Frederic S. Mishkin, a former Fed governor, noted that financial firms tend to resist increased regulation, often with considerable success. “They’re going to hire a lot of lawyers to figure out how to get around these regulations and undermine them,” Mr. Mishkin, a Columbia University economist, said.

This is the same Mishkin who argued, in late 2011, it was necessary to regulate Too Big to Fail banks:

Too-big-to-fail is now a larger problem than before, in part because banks have merged in a way that creates even larger banking institutions and because, with the Fed bailout of Bear Stearns in March 2008 and then the financial assistance to AIG by the Fed and the U.S. Treasury in September of 2008, it has become clear that a much wider range of financial firms are likely to be considered “too big to fail” in the future. Indeed, the most prominent case of a firm that was not bailed out—Lehman Brothers in September 2008—was followed by such a severe crisis that it is unlikely that governments would let this happen again. In the wake of the Lehman failure, governments throughout the world bailed out or guaranteed all their major financial institutions.

One way to address the too-big-to-fail problem is to limit the size of fifinancial institutions, which might involve either the breakup of large fifinancial institutions and/or limits on what activities banking institutions can engage in. However, arbitrary limits on their size or activities might well decrease the effificiency or raise other risks in the fifinancial system. An alternative approach is to subject systemically important institutions to greater regulatory oversight, say by a systemic regulator. . ., or by imposing larger capital requirements for systemically important financial firms.

The Dodd–Frank financial reform bill passed in summer 2010 gives the federal government one more tool for dealing with systemically important financial companies. Before Dodd–Frank, the U.S. government only could take over individual banking institutions, but not fifinancial holding companies that own banks and other fifinancial institutions. (In other words, it could take over Citibank, but not Citigroup or a free-standing investment bank like Lehman Brothers.) It used to be that the government had only two alternatives with such fifirms: send them into bankruptcy or bail them out. Now, the federal government has “resolution authority” over such fifirms, which means that they can treat them as they would an insolvent bank. Critics have expressed concerns that this federal resolution authority will further entrench too-big-to-fail and so make the moral hazard problem worse. . . As with all regulatory authority, the devil will be in the details. But the new resolution authority is likely to help limit moral hazard because it gives the government a big stick to force systemically important financial institutions to desist from risk taking or to raise more capital—or else face a government takeover that imposes costs on managers and shareholders.

On one hand, according to Mishkin, we have Too Big to Fail banks, which are “now a larger problem than before,” that need to be regulated. On the other hand, also according to Mishkin, the banks will resist regulation by hiring a lot of lawyers “to get around these regulations and undermine them.”

So, why are we repeating the mistakes of the past, after the last great depression, when the banks were left with both the incentive and the means to evade and ultimately overturn the regulations?

Economists like Mishkin might even write that up in a working paper if only we paid them enough money.

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