REGULATION FOLLOWUP....British prime minister Gordon Brown, everyone's hero of the financial moment, talks about reform:
"Sometimes it does take a crisis for people to agree that what is obvious and should have been done years ago can no longer be postponed," the British prime minister, Gordon Brown, said in London in a speech calling for the adoption of a new Bretton Woods-style agreement among major countries. "We must now create the right new financial architecture for the global age."
I mentioned a few days ago that I'd been noodling about this, and I certainly think there's value in talking about specifics: imposing transaction fees on financial trades, tightening up mortgage rules, requiring that credit default swaps be traded on an open exchange, and so forth. But the big picture always seems to come back to two things:
Task central banks with paying more attention to asset bubbles. Alan Greenspan famously thought we should just let bubbles inflate away and then deal with the aftermath as best we can, but events of the past decade really don't make that seem like such a great idea anymore. What's more, this piece of the puzzle probably doesn't even require drastic regulation. It's not a matter of trying to get rid of bubbles completely, after all, but of trying to keep them just a wee bit more under control. If we had managed to restrain the housing bubble by even 20% or so, for example, that might very well have made the difference between tough times and global crisis. At the very least, central banks should refrain from throwing fuel on the fire, and should try to persuade government actors to do the same. Combine that with some modest monetary brakes when bubbles are plainly out of control, and we could avoid a lot of future trouble.
Regulate leverage everywhere, not just in the formal banking sector. This is probably even more important. If the subprime bubble had been our only problem, it probably would have meant systemwide losses of half a trillion dollars or so. Maybe a trillion. That's nothing to sneeze at, and all by itself it would very likely have led to a few big bank failures, some big losses in the stock market, and a nasty recession. But that's merely a disaster. It was the additional leverage from derivative trading based on the underlying loans that turned a disaster into a global meltdown.
Figuring out how to fix this is a gargantuan task that's several light years above my pay grade. Simple financial leverage is straightforward enough, but effective leverage hidden in complex debt instruments, often off balance sheet, makes this a regulatory nightmare. Realistically, I suppose it probably needs to be some kind of extension of Basel II with more scope and more bite, but one way or another, after years of talking about the dangers of stratospheric leverage but taking very little actual action to rein it in, something has to be done. If we're looking for work for all the rocket scientists who have been let go from their Wall Street jobs recently, this might not be a bad place to start.
So who should be our go-to guys on this subject? It seems like liberals were caught sort of flat-footed by the Paulson bailout plan, which made it difficult (though, in the end, not impossible) to quickly sell Congress on a different strategy. This time around, when the conversation starts, it would be nice to have some coherent strategies already on the table from people we trust. Any suggestions?