Already the bank lobby and its hangers-on have come out to criticize the White House's new financial regulation proposal, arguing that it won't do much to solve the problems we saw in 2008. (They don't mention how it will eat into their profits.) Their analysis is wrong for a couple of reasons, mainly because it forgets -- as people often seem to -- that this proposal is part of a broader regulatory overhaul currently moving through Congress. There are two objections here:
One, from the bank lobby, is that proprietary trading and overall size did not cause the crisis. Depending on your definition of "cause," this could be true, but there is no denying that the massive risk carried by these trading desks both exacerbated the asset bubble at the center of the crisis and forced government intervention in some cases when commercial banks (like Citibank, for instance) had huge losses at their trading desks, endangering deposits. If you want to do proprietary trading, it's pretty simple: You can't do it with the Fed discount window wide open or using depositors' money.
Two, The Business Insider's Henry Blodget says the proposal won't fix a thing because bailouts are still possible. Blodget hasn't bothered to learn about the rest of the Obama administration's regulatory reform proposal, which does have dissolution authorities that hypothetically allow any financial institution, whether an insurance company, an investment bank or a commercial bank, to be liquidated by regulators, not bailed out. I've written about these ideas here and here.
I've been very bullish about dissolution authorities as a solution to the Too Big To Fail problem, but I don't think they can be used in a vacuum -- like most complex problems, financial regulatory reform requires a both/and approach. The government needs to be able to protect the socially important banking practices it guarantees from excessive risk, and it needs to be able to act to protect the entire financial system when a straight-up investment bank (or any other financial institution) lets risk get out of control (ideally, regulators would prevent that, but widespread regulatory failure over time seems to be a characteristic of modern finance). Basically, we need the tools to deal with the failure of a Lehman Bros. (dissolution authorities) and to protect a Bank of America or Citibank from relying on government support to protect it from reckless risk-taking (today's proposals).
Also, Jim Manzi has some smart things to say about why conservatives ought to appreciate this proposal, which is really in the tradition of separating necessary government subsidies (for deposit insurance and lender-of-last resort purposes) from unnecessary ones (making traders enormously wealthy). Sadly, conservatives in Congress are unlikely to agree with Manzi and will likely oppose this proposal en masse.
-- Tim Fernholz
