Simple Regulations Are Harder Than They Look

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John Quiggin wants to rein in big banks, and figures the best way to do it is to separate basic banking (taking in deposits, making loans) from everything else (trading, M&A, derivatives, etc.). Matt Yglesias objects, because we’re already trying to do a limited version of this with the Volcker Rule and it’s turned out to be really, really hard:

I could keep droning on about this, but I’ll stop. The point is that other people ought to drone on a bit more about which rules, exactly, they want to see put in place and why the objections to those rules are wrong. The general argument that the backstopped segment of the banking system should be ringfenced from the speculative bit is so persuasive that the U.S. Congress already passed a law purporting to do it. Yet obviously finance has hardly been dethroned from its commanding place in American political economy, and guaranteed banks haven’t stopped engaging in big speculative trades.

This is one of my perpetual problems with complaints about regulation. It’s easy to say we should have less of it, and probably we should. And yet, the plain fact is that we live in a really big, really complicated society. There’s just no getting around that. And that means our regulatory apparatus is going to be big and complicated too. I’m not sure there’s any getting around that either.

In the case of high finance, I happen to think that I’d probably trade all of Dodd-Frank for a simple but severe minimum leverage requirement. But even if we all agreed about that, it’s not as if that would be a trivially easy regulation to write. Leverage is a ratio, and you have to define both the numerator and the denominator, both of which are very complex when you’re dealing with big banks. You also have to make sure your new reg applies not just to chartered banks, but to the shadow banking system as well. (AIG wasn’t a bank, but its failure caused plenty of problems.) That adds yet more complexity. And then you have to stay ahead of all the bright boys and girls who will figure ways around your shiny new rule as time goes by.

And that’s the best case: a complex environment where, at least arguably, there’s a relatively simple rule that might serve us better than a thousand smaller rules. You really don’t run into that very often. In most cases, it’s really hard to think of a simple rule that works well and fairly. If you’re a libertarian who thinks a modern mixed economy can work great with only minimal regulation in the first place, this isn’t a problem. You’ll just take a chainsaw to the regulatory state. For the rest of us, though, the answers aren’t easy. It’s just not clear how a complex society can run without fairly complex rules.

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