The text of a speech to be given by Fed Chairman Ben Bernanke at the Council on Foreign relations has been posted. Here’s the executive summary:
We must have a strategy that regulates the financial system as a whole, in a holistic way, not just its individual components. In particular, strong and effective regulation and supervision of banking institutions, although necessary for reducing systemic risk, are not sufficient by themselves to achieve this aim.
Today, I would like to talk about four key elements of such a strategy. First, we must address the problem of financial institutions that are deemed too big–or perhaps too interconnected–to fail. Second, we must strengthen what I will call the financial infrastructure–the systems, rules, and conventions that govern trading, payment, clearing, and settlement in financial markets–to ensure that it will perform well under stress. Third, we should review regulatory policies and accounting rules to ensure that they do not induce excessive procyclicality–that is, do not overly magnify the ups and downs in the financial system and the economy. Finally, we should consider whether the creation of an authority specifically charged with monitoring and addressing systemic risks would help protect the system from financial crises like the one we are currently experiencing. My discussion today will focus on the principles that should guide regulatory reform, leaving aside important questions concerning how the current regulatory structure might be reworked to reduce balkanization and overlap and increase effectiveness. I also will not say much about the international dimensions of the issue but will take as self-evident that, in light of the global nature of financial institutions and markets, the reform of financial regulation and supervision should be coordinated internationally to the greatest extent possible.
Frankly, I found it deficient on a number of grounds.
The first is that he barely makes a mention of the trans-national character of many of the financial institutions he’s trying to regulate. It’s not just that these institutions are too big to allow to fail, it’s that no single national government has the tools to regulate them effectively. My own view is that, if any private company is too big to be allowed to fail, it’s too big to be allowed to exist. If you’re going to allow mega-banks that cross countries and oceans, you’ve got to develop the tools to regulate them or be prepared to take your licks.
Second, the world moves very quickly these days and regulation is inherently backward-looking. How can you regulate institutions if you don’t even understand what the heck they’re doing?
Finally, I’m not certain how you can avoid regulating pro-cyclically when legislators are merrily stimulating the economy pro-cyclically. In all of the re-discovery of Keynes’s ideas (Keynes was God when I was taking economics) no one seems to have noticed that he advocated cutting back on government spending as well as stimulus packages. Binging is so much more fun than purging.
That’s the main issue I had with Keynesian remedies – nobody is willing to do what must be done in boom times according to Keynes, which is to raise interest rates, cut spending, and raise taxes, in order to restore order to the federal budget and smoothen out the booms to avoid bubbles.
Keep an eye out for David Leonhart’s “Economic Scene” column in the New York Times tomorrow (I’ve seen an advance copy on the wire). It should be titled “The Looting of America’s Coffers” or something like that. It gets to what I think is the gist of the problem.