The Case for Patience

In response to Dean’s response [1], let me begin by clarifying my position on a timeline for regulatory reform.

I don’t believe we need to wait for a year or more before beginning the effort to reshape the financial system—in fact, I think we could begin right now. I would like to see the White House and the Congress working toward a comprehensive regulatory overhaul this very minute, which might be put up for a vote within a matter of months. What I don’t think we should do is rush the reform process through as an explicit response to this crisis. What we’d like the financial system to look like a year or two down the road should not be a major consideration in determining how to achieve financial stability now. The priority should be addressing the immediate crisis in as effective a manner as is possible given constraints.

[2]

Should We Bail Out This Bailout?

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Having said that, I think it’s most helpful to divide Dean’s proposals into two categories. The first is his proposal for immediate resolution of the problem of potentially insolvent banks. He says:

That is real simple. The shareholders get wiped out and the bondholders likely get wiped out too. That's the way capitalism is supposed to work.

This is the kind of message that should appeal to angry voters—take over the banks and wipeout the fat cats what created the mess. I don’t believe that following this path would have the effect Dean desires, however. Restructuring one or a handful of banks would leave most of the difficult work to be done—it wouldn’t obviate the need to regulate leverage and behavior. Even if nationalization could be accomplished in the cheapest manner possible—by wiping out bondholders—it’s likely that the process of cleaning up a Bank of America or a Citigroup would be quite expensive (particularly if depositors got nervous and began withdrawing funds). This expense would mean that new appropriations for the banks would be necessary, which would no doubt blunt the public’s satisfaction at having a big bank go down.

Further, and as Dean knows, there is some risk (and potentially a significant risk) that nationalization would touch off a new round of financial instability. This wouldn’t only prove damaging to the administration’s efforts to reform the financial stability; it would also threaten the Obama presidency and the whole of the progressive agenda.

Dean’s other regulatory proposals are sound in principle, and I hope they are incorporated in whole or in part into legislation. But here, too, I think it’s better to take one’s time and produce the best legislation possible rather than rush ahead to take advantage of public sentiment. For one thing, I doubt that anger at bankers will wane in the near future, but for another, I’m skeptical that this anger can be channeled into an effective regulatory framework. “Let the banks fail,” is a rallying cry. Even, “Reduce financial compensation,” could resonate with the public. “Alter the procedures by which Fed presidents are chosen,” is destined to cause eyes to glaze over.

Just have a look at the recent fate of mortgage cramdown legislation. This should have been something the public could rally behind, and it certainly should have been an issue on which standing with the banks proved politically poisonous. And yet stand with the banks legislators did, enough of them to kill the measure. Anger works for bringing down people and institutions. At fine-tuning rules it is of limited utility.