And he's got an interesting post on the idea of TBTF, which has been a big part of the debate in the past few days over the financial regulation reforms. On one hand you have people like Bob Reich saying that the plan doesn't eliminate the problem of TBTF, which is true to a certain extent. On the other you have conservatives who say that the plan enshrines TBTF, which isn't true. The administration says that the TBTF is sort of a red herring: It's not just size; it's also interconnectedness -- Lehman, as these folks like to point out, was not too big, it was too interconnected. Paul Krugman looks at the problem and comes down on the Treasury side:
I’m a big advocate of much strengthened financial regulation. One argument I don’t buy, however, is that we should try to shrink financial institutions down to the point where nobody is too big to fail. Basically, it’s just not possible.The point is that finance is deeply interconnected, so that even a moderately large player can take down the system if it implodes. Remember, it was Lehman — not Citi or B of A — that brought the world to the brink.
And as far as I know, there never was a time when policymakers could have viewed the collapse of a major money center bank with equanimity.
... So I think of the pursuit of a world in which everyone is small enough to fail as the pursuit of a golden age that never was. Regulate and supervise, then rescue if necessary; there’s no way to make this automatic.
That's certainly the administration's approach -- by identifying firms that are too large, leveraged or interconnected and imposing special additional regulations, they hope to keep large firms acting in a stable way. The new resolution authorities, which will allow them to be thrown into recievership in a responsible way should they fail, will (and this is the talking point) eliminate the false choice between a catastrophic failure and an expensive bailout.
As a sidenote, Krugman's increasing mastery of blogstyle is really worrying me. If he's got Nobel-prize winning smarts AND posts about beer, there's no way to compete. (Special bonus for econ students: Identify my comparative advantage relative to Krugman).
-- Tim Fernholz
