March 10, 2009
Bernanke on Financial Regulatory Reform
Posted by David Zaring

Ben Bernanke just spoke on what he thinks is necessary for regulatory reform:

First, we must address the problem of financial institutions that are deemed too big--or perhaps too interconnected--to fail. Second, we must strengthen what I will call the financial infrastructure--the systems, rules, and conventions that govern trading, payment, clearing, and settlement in financial markets--to ensure that it will perform well under stress. Third, we should review regulatory policies and accounting rules to ensure that they do not induce excessive procyclicality--that is, do not overly magnify the ups and downs in the financial system and the economy. Finally, we should consider whether the creation of an authority specifically charged with monitoring and addressing systemic risks would help protect the system from financial crises like the one we are currently experiencing.

Some observations:

  • Bernanke agrees with observers like Paul Volcker that big financial institutions should become smaller.
  • Strengthening the financial infrastructure means, in part, more organized clearinghouses - that is, exchanges on which credit default swaps et al can be traded openly.  This is a pro-market sort of reform.
  • Protocyclicality is related to Bernanke's first point about the beauty of smallness - the idea here is more and higher reserve requirements, which will make banks and other financial institutions less profitable.  This is a command and control sort of reform.
  • A systemic risk regulator involves creating something that does what the Federal Reserve does now, and it isn't clear whether Bernanke wants explicit authority for this, or more attention to it, or wants to create something new.  His turf protective statement, made mildly: "addressing systemic risks would seem to require the involvement of the Federal Reserve in some capacity, even if not in the lead role."
  • It is a complex set of recommendations, actually - read the whole speech to see all the myriad details - but one way to understand it, and financial reform generally, would be to look at the regulatory system as either fragmented, the way it was, semi-centralized, the way it has become during this crisis, or bureaucratized and rationalized, along the lines that Paulson, Volcker, and now Bernanke seem to suggest.  A lot of people want that Weberian rationalization.  But really, there is a very long pedigree for the system we used to have - decentralized, functionalist, open to regulatory competition and races to the top.  Amid all the cries for reform, the advantages of mess - that is, a system where random states like Delaware play roles along with the federal government, where agencies like the SEC and CFTC compete for business - are easy to overlook.

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