Knights Who Say… (Twofer Edition)

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James Kwak, highly respected economics blogger, catches up with me, Bernanke, Yglesias, Paulson, Spitzer, Klein, Volcker, Johnson, Bair, and A New Way Forward.  First he rues the fact, as I did, that the Obama administration seems fixated on the “to fail” part instead of the “too big” part:

Given the existence of “systemically important firms,” I agree they need careful regulation. But why does Geithner assume that they have to exist at all?

Then he provides a longish and quite detailed argument, including:

Clearly some financial institutions reached a level of scale and complexity where they simply could not even understand what they were doing, let alone manage their risks appropriately; they were too big, looked at just from their own perspective (and excluding the implicit Too Big To Fail subsidy). To this equation, we now need to add the social costs (negative externalities) of being Too Big To Fail: moral hazard, socialized losses, and so on . . .

When you are designing regulation, you have to bear in mind that the world will change. But this is another reason why simpler is better, and the simplest solution is simply to prevent firms from becoming Too Big To Fail in the first place. First, you have to expect that no matter how clever your regulatory scheme, some firms will be even more clever in finding ways to evade the system and blow themselves up. You are far better off if they are small when they blow up than if they are big.

And Sir Yglesias catches up with my analogy to anti-trust legislation.

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One Response to “Knights Who Say… (Twofer Edition)”

  1. Knights Who Say… « Hungry Hungry Hippos Says:

    […] Who Say… By urbino TPM’s Josh Marshall catches up with me, Bernanke, Yglesias, Paulson, Spitzer, Klein, Volcker, Johnson, Bair, Kwak, and A New Way Forward: When do we downsize these banks? A key part of the crisis, perhaps the key part of the crisis is […]

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