A Debate On Regulation

Interesting debate on the Economist about regulation going forward. Please read it.

Stiglitz wants more regulation, and sees too little regulation going forward as the problem, due to the lobbying power of financial concerns:

"Why, with the extra cushion of taxpayer money, of the kind proposed in the British bail-out, without such reforms, should we expect them to behave much better in the future than in the past?"...

"Part of a new regulatory system must be a financial products safety commission, to make sure that no products bought or sold by commercial banks or pension funds are “unsafe for human consumption”. Ideally, such a commission would try to encourage the kind of innovation that would protect homeowners and make our economy more efficient."

I certainly agree with Stiglitz that, if the government is going to guarantee these businesses, that regulations minimizing the risk to taxpayers should be expected. However, count me skeptical about the "Financial Products Safety Commission" being effective, except in an ideal world. Notice that this is separate from proposals about the Fed trying to minmize bubbles.

Arguing against regualtion, Scholes wants banks, for instance, to be less leveraged by holding more capital:

"Although governments are able to regulate organisational forms, they are unable to regulate the services provided by competing entities, many yet to be born.

"The simple remedy, therefore, is to require banks to have less leverage or—its converse—to have additional equity capital"...

"Although additional equity capital and less debt capital will not reduce the total value of the bank, it will reduce the expected return on equity. This is of no consequence, however, since with less debt the risk of the equity is correspondingly less. The return-to-risk tradeoff is unaffected. Investors will need to expect a lower return on equity capital. If individuals, hedge funds, etc, want to achieve a greater expected rate of return with commensurately more risk, they are able to achieve such by leveraging on their personal accounts...

Capital is the solution and it is a form of “light regulation”. "

I tend to like Scholes proposal more. However, I want to know before hand if, and to what extent, government intervention is expected. I want that debated up front.

On another post, here, I discussed the problems with the Fed trying to stop bubbles. So far, Scholes "light regulation", which I take to be a requirement, seems the most sensible proposal to me.