The Great Recession and Reform

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While living in the Bucknell bubble, I tried to avoid hearing about the financial crisis.  I guess my thinking was the less I knew about it, the less real it was.  This was when I was a naïve sophomore, but now as a junior I am much wiser (maybe) and I realize that it is better to be informed and understand the financial recession than to have no idea what is happening.

I read the blog post Financial Regulation and Fools from the blog the Baseline Scenario, which lead me to two opinion pieces in the New York Times regarding Financial Regulation.  The first was Financial Reform 101 which discussed whether more bank regulation or breaking up big institutions would be a better reform. The article Making Financial Reform Fool Resistant by Paul Krugman explored the latest financial reform legislation put together by Senator Chris Dodd.  Clearly reform needs to happen, but the question is how to do it properly.

As Krugman mentions in his first column, there are two arguments surrounding financial reform.  The first is to limit the size of institutions so that there are no more banks that are too big to fail.  Select institutions were so large that the government bailed them out, fearing that letting the institutions collapse would worsen the financial crisis.  This has set a dangerous precedent because now big banks know that in case of financial distress the government will bail them out.  Krugman says that the solution is to limit the size of the banks so that there are no more banks that are too large to fail.  Krugman dismisses this argument by mentioning that the financial collapse of 1930 was comprised of a run on smaller institutions.  I am inclined to agree with Krugman.  A large number of small banking institutions taking on excessive risk can be just as dangerous as the few institutions too large to fail taking on excessive risk.

The other argument regarding reform is for more banking regulation.  Krugman points to Canada as an example; Canada has large banking institutions but sufficient regulation which is why they have not been able to survive the financial crisis as well as they have.  There is banking regulation currently, but this regulation does not affect “shadow banking,” which are institutions that carry out banking activities but have minimal regulation.  I think that regulation is the best solution for reform.  I think that these institutions have made it clear that they cannot make decisions regarding risk on their own.

The second column by Krugman discusses the current proposed legislation regarding regulation.  This legislation would leave much of the regulation up to the good judgment of government officials.  I agree with Krugman that there should not be that much left up to the personal judgment of government officials.  It gives them too much opportunity to look the other way when they don’t think something appears to be a big problem.  This is leaving too much up to the personal attributes of the government officials.  Depending on who the official is, the response to certain problems will change.  I think there should be more specific regulation, as there has been for standard banking practices.  I think this will lead to more stable banking practices because their actions will not be judged differently depending on who is the official.  This is a case where the thoughts and opinions of the person should be as removed from the situation as possible, however it seems that in order to be passed this legislation will remain weak, which is really unfortunate.

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3 Responses

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  2. Emily both our posts touch on the similar topics of financial reform and regulation. The difference is I leaned a little more toward the political division of the regulation and which party wants what type of reform. My post, How to Reform? The Big Question, has had a few really interesting comments that tie into your topic as well. In the New York Times today the article G.O.P. Takes Aim at Plans to Curb Finance Industry hits many interesting points in the financial regulation and reform legislation going through the government now. It also hits on the effects that up coming politics and upcoming election is having on the Dodd bill.

    My feelings on the topic of financial regulation are that strict and traditional reform and legislation has allowed banks and financial institutions to find loopholes and ways around it too easily. The present bill is using the Financial Stability Oversight Council as a way to introduce flexibility to assist regulations to remain affective and reduce the loopholes and evasion of older and more rigid regulations.

  3. I agree that financial institutions have managed to find loopholes in traditional legislation, however, I think that is reason to strengthen the legislation and regulation of banks. I think that the Financial Stability Oversight Council could leave too much judgment in the hands of individuals. As Paul Krugman says in his article Making Financial Reform Fool-Resistant, this leaves a lot up to human judgment, and error. He points out that in 2005 Alan Greenspan would have been on the Financial Oversight Committee, and Greenspan dismissed warnings about the housing market bubble. There were many years of economic stability in the period post-world war II, with the exception of a few recessions. Clearly legislation was working until a new kind of banking emerged that the existing legislation did not control. I think that the Financial Oversight Committee could be beneficial in allowing for some flexibility, but I think they should only be used in addition to strict regulations.

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