Would regulation make the U.S. economy safer...and less prosperous?

The Associated Press

Henry Paulson is under pressure to fix the economy.

Featured Topic | Posted 14 weeks 6 days ago

Would regulation make the U.S. economy safer...and less prosperous?

Treasury Secretary Henry Paulson's plan to overhaul the U.S. financial system includes a crucial proposal: it would officially transform the Federal Reserve into a “market stability regulator” rather than merely a banker’s bank. Is that the kind of transformation the markets need? Does America?

This aspect of the Treasury plan appears to be a natural step in a historical trend. The Fed is no longer just a regulatory agency presiding over a narrow group of businesses called banks. Rather, its mission increasingly is to maintain macro confidence -- confidence that the entire financial system is functioning well as part of the whole economy.

In recent years, central banks have not always managed macro confidence magnificently. The Fed failed to identify the twin bubbles of the last decade -- in the stock market and in real estate -- and we have to hope that the Fed and its global counterparts will do better in the future. Central banks are the only active practitioners of the art of stabilizing macro confidence, and they are all we have to rely on.

Does Paulson's plan represent a positive step? Should Congress do more? Why should government regulate economies at all? Should the forces of the marketplace be left to their own devices? Shouldn't there be winners and losers? Or should government guarantee the livelihood of institutions that are "too big to fail"?

Ben likes: Paulson's war on the markets

Terence Corcoran/Financial Post

The Bush administration's Homeland Security regime, a massive anti-terrorism overkill that continues to burden Americans with excess regulation (and Canadians with border paralysis), may not be cost effective, but it appears to be the model for the U.S. government's assault on the financial markets.

In the wake of 9/11, George W. Bush had the U.S. government consolidate scores of agencies into one big Department of Homeland Security. The result, by most accounts, has been a dysfunctional operation that, among other things, created an expensive bureaucracy that may or may not have been instrumental in securing U.S. borders. The indirect economic costs -- in lost border trade and efficiency -- would far exceed the direct billions spent screening trade and travel.

If it didn't work well the first time, let's try it again. Treasury Secretary Hank Paulson plans to bring the same thinking to police financial markets as Homeland Security brought to policing terrorism. Hit the problem with massive regulatory intervention, consolidate scores of existing agencies, and build a new, costly and more interventionist regime.

Joel likes: Don't trash Paulson's blueprint

Clive Crook/National Journal

Paulson said this week, "The blueprint is about structure and responsibilities, not the regulations each entity would write." What those regulations actually say, and how competent the regulators are in enforcing them, are obviously critical.

New curbs are needed on mortgage lending; on off-balance-sheet risk; on the opacity of new financial instruments. The blueprint has nothing to offer on any of this. And even if you accept the plan for what it is, it has another big gap. The authority of its prudential regulator is confined to institutions that benefit from "explicit government guarantees" -- meaning deposit-taking banks. But the government's safety net is not confined to firms with explicit guarantees. In emergencies, it deems other institutions (such as Bear Stearns) too important to fail.

Ingenious as markets may be, an exaggerated cycle of credit-driven boom followed by panic-induced bust is neither desirable nor necessary. Better financial regulation can help to attenuate the ups and downs. It is a matter not of more regulation or less, but of making the rules smarter. How to do that is a discussion that has barely even begun.