There is often a conflict between policies that make things feel good in the short run and those that are optimal in the long run. This is one reason why I am fairly pessimistic about global warming—the world’s political systems are not well suited to addressing this issue.
Perhaps the most famous example in the field of economics is the public debt. Decisions to reduce the public debt (higher taxes and/or lower spending) are exceedingly unpopular in the short run, and only pay off in the distant future. Thus I expect our fiscal situation to get worse over time. Indeed it’s amazing that it did not become unsustainable until the mid-2010s.
Bank regulation is another area where this problem occurs. The best regulatory structure is probably no regulation at all. Unfortunately, the creation of deposit insurance and too-big-to-fail has made that option infeasible. Without regulation, banks would have the incentive to take wildly excessive risks with the taxpayer’s money. One option would be to eliminate both deposit insurance and bank regulation.
The second best policy is higher capital requirements. But these are often so complex that clever banks can occasionally find ways to evade the intent of the rules.
And then there’s “greater supervision”. This is roughly the equivalent of a politician telling voters they plan to reduce the budget deficit by addressing “waste, fraud and abuse.”
A recent article in Bloomberg caught my eye:
President-elect Donald Trump’s advisers are considering how they will reshape the leadership of the Federal Reserve including elevating Fed Governor Michelle Bowman to be the central bank’s next vice chair for supervision, according to people familiar with the matter. . . .
She has spoken widely about bank regulation, often to community banking audiences. She strongly opposed Barr’s bank-capital proposal, part of an international agreement known as Basel III that is intended to prevent future bank failures and another financial crisis, arguing that increased capital requirements would likely curb lending activity at a time when the banking sector was healthy. Instead, she has said banks need better supervision.
Why not someone like Christopher Waller?
Fed Governor Christopher Waller, who has previously been considered a possibility for chair, may no longer be under serious consideration after he backed a half-point interest-rate cut in September, the people familiar said. Trump called the larger-than-usual Fed cut, just weeks before the presidential election, “a political move to try and keep somebody in office.”
Even in the best of circumstances, it is unlikely that better supervision would adequately address problems in the banking system. But after the recent reversal of the Chevron decision, it’s even less likely that bank regulation will be effective. Here’s Amy Howe:
In a major ruling, the Supreme Court on Friday cut back sharply on the power of federal agencies to interpret the laws they administer and ruled that courts should rely on their own interpretation of ambiguous laws. The decision will likely have far-reaching effects across the country, from environmental regulation to healthcare costs.
Bank regulation is based on some of the most ambiguous laws on the books.
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