This is a good point by Tyler Cowen:
The ad hoc aspect of the bailout created a precedent for what has come to be called “regulation by deal” — now the government's modus operandi. Rather than publicizing definite standards and expectations for bailouts in advance, the Fed and the Treasury confront each particular crisis anew. Decisions are made as to whether a merger is possible, whether a consortium can be organized, what kind of loan guarantees can be offered and what kind of concessions will be extracted in return. So far, every deal — or lack thereof, in the case of Lehman Brothers — has been different.While there are some advantages to leaving discretion in regulators' hands, this hasn't worked out very well. It has become increasingly apparent that the market doesn't know what to expect and that many financial institutions are sitting on the sidelines, waiting to see what regulators will do next.
To be fair, I think the "regulation by deal" label is actually misleading. The bailouts are examples of government response, not regulation. But they have identified a crucial area of regulatory uncertainty: The "too big to fail" problem. The government's standards for responding to the collapse of a "too big to fail" institution are, as of now, nonexistent. They need to be clear. And they need to be harsh. Punitive, even. They should include the automatic elimination of the company's top level executives and board of directors. You can argue that there should be personal liability for those executives if negligence can be proven. Why shouldn't the risks taken by the richest involve the possibility of ruin -- they certainly involve tat possibility for the rest of us. They should include takeover, and a repayment schedule that makes investors a profit before it makes shareholders whole. Sound unfair? Maybe. But the point of regulation -- as opposed to response -- is that it attempts to keep something from happening. It's now clear that the incentives for caution were insufficient when set against the incentives for profit. The mechanism is clear: Shareholders have short memories, and they were looking for high returns, and firms that did not offer such returns would lose business. The market can stay irrational longer than you can stay solvent, or so goes the old line. It may be that there's nothing regulation can do about that. In 40 years, this crisis will be forgotten, and the market will have convinced itself that exotic new instruments had eliminated the possibility of downside risk. Or it may be that a regulatory structure that is punitive in the face of collapse to both executives and shareholders will force different behavior, at least among cautious firms, at least during the late stages of a bubble. In either case, the government should be clear on what it will do. Response-by-deal is far worse than a response according to clear rules.
