One of the signature challenges of the current recession is its global aspect; no matter what policy changes are undertaken here in the United States, the interconnected nature of the world economy leaves conditions here in the U.S. somewhat at the mercy of decision makers in other countries. More than one observer has suggested that it is time to revisit an international economic regulatory regime ala the post-World War II Bretton Woods agreement. Which is why it is interesting that today a report on just that subject has been released by a group of top international economists. Its lead author is Paul Volcker, former Fed Chair and current Obama adviser.
The report [PDF] contains 18 recommendations focused on preventing the untenable situation we refer to as "too big to fail." That condition comes about when a financial institution makes bad business decisions but its size and reach prevent the government from allowing it to fail because of potentially devastating economic consequences. Thus, the report suggests creating unitary national regulatory authorities, limiting the size of bank holdings and executive compensation, and restricting the amount of risk that different financial institutions would be able to take on, preventing, for instance, banks from managing private equity or hedge funds, and mutual funds from acting as investment banks. It's the kind of stuff that might prevent future financial crises and help ensure the smooth working of our capitalist system, if properly implemented.
It's also the kind of thing that will make Wall Street furious. The enormous profits of the financial industry are based on taking enormous risk. Of course, when those enormous risks don't pay off, it's not the private companies that take the heat, it's the public. Businesses have a right to operate in a free market environment until their actions have a detrimental effect on everyone else, but then the government must step in. These proposed regulations are part of a general initiative -- one that will be led here in the U.S. by Congressman Barney Frank -- to limit public risk by regulating private business.
Of course, it's difficult to create effective regulatory regimes, especially on the international level. This will be a thorny problem sure to consume a good deal of time, post-stimulus, for Obama's economic team.
For further reading on this topic, let me suggest Harold Meyerson's article in our most recent issue, "A Global New Deal."
-- Tim Fernholz
