Paul Krugman's column today begins with a shot at Larry Summers but quickly turns into one of Krugman's best. In it, he gracefully tracks the recent growth of the financial sector, tracing its transformation from "a staid, even boring business" that accounted for less than four percent of GDP in the 1960s to a monstrously lucrative and risky industry that was more than eight percent of the GDP of the world's largest economy. How you understand the regulatory implications of that growth, Krugman says, is crucial to how you understand Geithner's plan:
Much discussion of the toxic-asset plan has focused on the details and the arithmetic, and rightly so. Beyond that, however, what's striking is the vision expressed both in the content of the financial plan and in statements by administration officials. In essence, the administration seems to believe that once investors calm down, securitization — and the business of finance — can resume where it left off a year or two ago.To be fair, officials are calling for more regulation. Indeed, on Thursday Tim Geithner, the Treasury secretary, laid out plans for enhanced regulation that would have been considered radical not long ago.But the underlying vision remains that of a financial system more or less the same as it was two years ago, albeit somewhat tamed by new rules.
That's exactly right. I've been thinking about this in more radical terms. To be more specific, I've been thinking about this in terms of antitrust law. In its simplest terms, antitrust law addresses the dangers of size. In general, the danger it addresses is anticompetitive behavior, which usually takes the form of monopoly power, but can also take the form of collusion. In both cases, the effect is fairly simple: An economic threat to a functioning market.The "too big to fail" problem, which is a problem unique to the massive financial sector that has emerged in modern times, is also, fundamentally, a problem of size. A firm grows too large and the simple fact of its size poses a threat to the continued health and survival of the market. The dangerous mechanism here is not, to be sure, anticompetitive behavior so much as dangerous levels of interconnection. In that way, it's harder to speak of it in the moral terms that undergird antitrust law. But it is no less dangerous, and no less intrinsic to size. Which is all to say that I fall with Krugman on this: The financial sector should be smaller and regulated more tightly to curb the incentives that encourage wild risk. And more to the point, the individual actors should be smaller. There is no solution to the "too big to fail" problem save for breaking up firms that cant be allowed to fail, or preventing them from reaching that size in the first place.
