More Regulations May Not Prevent Another Financial Crisis

Market Failure or Government Failure? Regulators protect the bankers. They continue to lose sight of their responsibility to protect the public. From the WSJ 3-19-10, p. A19. Exerpts:

"Without the policies followed by Fannie Mae and Freddie Mac—and the destructive changes in housing and mortgage policies, like authorizing subprime and Alt-A mortgages for impecunious borrowers—the crisis would not have happened."

"Without warning, the federal government's 30-year policy of bailing out large banks changed when it allowed Lehman Brothers to fail."

"The new financial regulations, spearheaded by Sen. Chris Dodd (D., Conn.), only bring back too big to fail by authorizing a Systemic Risk Council headed by the Treasury secretary.

"Regulation often fails either because regulators are better at announcing rules than at enforcing them, or because the regulated circumvent the regulations."

"This is because regulation is static, while markets are dynamic. If markets don't circumvent costly regulation at first they will find a way later."

"The answer is to use regulation to change incentives by making the bankers and their shareholders bear the losses."

"Secretaries Timothy Geithner and Hank Paulson told Congress at the AIG hearing earlier this month that they faced a choice: a bailout or another Great Depression. This is not true. Classic central banking offered a better alternative. Let AIG fail and lend to the market on good collateral. The Fed, acting as lender of last resort, should protect the market—not the failing firm."

"The market is not perfect. It is run by humans who make mistakes. But the same humans run government where they make different, often more costly, mistakes for which the public pays."

"Regulators talk a lot about systemic risk. They do not—and probably cannot—give a tight operational definition of what this means."

"We will not get sound banking until the CEOs of the large banks and their shareholders are forced to pay for their mistakes."

The author was Allan Meltzer, a professor of economics at Carnegie Mellon University, is the author of "A History of the Federal Reserve" (University of Chicago Press, 2004) and a visiting scholar at the American Enterprise Institute.