Muppet News Flash: An upcoming report from ProPublica and NPR promises to break the shocking story that the Fed is a victim of regulatory capture and has taken a kid-glove approach to Goldman Sachs et al.
There is much in this that promises to be embarrassing, but it is important not to take the wrong lessons from it.
Bank regulators spend 90 percent of their time worrying about a dozen firms. Given the trend toward consolidation in banking, it is likely that the Fed and other regulators will spend even more time and energy on an even smaller number of firms.
What do you imagine that relationship is going to look like?
The banks hold their regulators in general contempt; the regulators themselves are often B-team veterans of those banks, or people who hope one day to make a great deal of money working at those banks. The banks and other financial institutions are the movers in the relationship; the regulators try to keep up, generally poorly. The problem is not only or even mainly such-and-such an officer at such-and-such an agency. We may need to fire a bunch of people at the Fed, and we may need to restructure the Fed’s chain of command and accountability practices. Those may be necessary actions, but they will not be sufficient to solve the fundamental problem: Pointillist regulation in which the Fed et al. attempt to create a regulatory mirror-image of innovation in the financial sector is never going to produce the stability and predictability that regulators always promise. Regulatory reform should attempt to move away from complexity toward simpler, universally applicable rules.
One of the reasons that we had bailouts was because nobody believed that our bankruptcy system was capable of dealing with a financial crisis, and little has been done to change that. A little bit has been done on leverage limits, but probably not enough. By all means, go on a merry scalp-collecting expedition through the New York Fed, if it’s warranted.
But don’t imagine you’ve solved your problem.