Economists say, “more banking rules, please”

Over the last several days the annual meeting of the American Economic Association has been taking place in my hometown of Denver.  A recurring theme is developing as presenter after presenter talks about their work.  That theme is that there needs to be more reform for banking laws.  Specifically the professors are saying the following:

• hedge funds still are not regulated enough and how will failure at these institutions be dealt with by regulators?

My comment: one of the problems for regulators is that by stating how they would deal with a crisis at a hedge fund, the hedge funds will then know exactly how they can skirt any rules.  Better: for regulators to have a plan in place but not disclose the details until it becomes necessary.

• the new equity capital requirements don’t provide that much of an increase in the safety of banking institutions

I agree.  The big complaint from banks is that the more money they hold in equity = less money for lending.  They argue that less supply of lended funds will result in higher interest rates.  Duh!  But that begs the question: is that necessarily a bad thing?  The price of money – i.e. interest rates – has been artificially too low for too long.  Interest rates are supposed to reflect the risk of the borrower, but ironically, low interest rates have really related the risk of the entire banking system.

• the new regulations are not simple enough

I agree.  I am all for simple regulations.  The more complex a regulation is then the more likely it is that there are loop holes.  Then banking institutions can claim ignorance of “how to implement” the rules properly when things go badly.

• clarity about how governments will handle another crisis at the level of the individual bank

Disagree.  See my above comments.

• banks over reliance on financing themselves with short-term debt

Totally agree.  This strategy is designed to increase profits because the spread between the cost of borrowing at the institution vs. its profits from lending, is higher.  The problem is what happens when debt markets seize up (hello! Lehman Brothers)?

As long-term readers of this blog know, I feel that an ethical, flexible regulatory framework is essential for the functioning of capitalism.  Kudos to the economists for speaking up about the need for more reform.

Jason