Reining In the Banks - Economist Roundtable

by: The Baseline Scenario

By Simon Johnson

The Economist is running an on-line discussion of Dani Rodrik’s article in their print edition on re-regulation strategy. The full discussion is here - follow that link for my contribution, the reactions of others, and Dani’s original piece.

Here’s what I said.

Dani Rodrik is right that good financial regulation begins and pretty much ends at home. Attempts to build a global regulatory structure, for example as currently under discussion by the G20, seem unlikely seriously constrain the ability of big banks to get themselves - and the rest of us - into major financial disasters.

These big banks are very powerful, exerting a great deal of political influence in the United States and arguably even more in some other industrialized countries. The U.S. bristles at potentially critical footnotes in IMF documents assessing its macroeconomic policies - how would it react to tough language or even real action from an international body that claimed supervisory authority over American banks?

The strong position of the U.S. vis-à-vis the International Monetary Fund (NYSE:IMF) has, for a long time, been an awkward reminder that all members of the IMF are not created equal. But of late, with deep flaws in the heart of the world’s largest financial system, the asymmetry of international power and lack of effective oversight over the U.S. is actually dangerous for the world economy. There is no global solution to this very American problem.

The only way forward is to dramatically change the effectiveness of regulation in the U.S. But this will not happen primarily through tweaking de jure rules or attempting to create one regulator with responsibility for the whole system - whether or not this is the Federal Reserve. Again, the banks have too much power - they will capture, influence, or arbitrage their way around any regulatory structures so that the next bubble, whenever and wherever it appears, will be at least as damaging as the last.

We need to break or substantially reduce the political power of the banks in the U.S. and in all other countries where this is a pressing first-order issue. This is a tall order, but if the problems gain sufficient visibility and our political leaders focus, we can make progress.