Issue of the week: The return of regulation

last updated 8 January 2015

Josef Ackermann, CEO of Deutsche Bank, neatly summed up the sea change that has swept through the financial world, said Michael Skapinker in the Financial Times. “I no longer believe,” Ackermann said last week, “in the market’s self-healing power.” Not long ago, no self-respecting capitalist would have voiced such heresy and essentially admitted the need for more government regulation. But faith in the wisdom of the free market has been shaken by “the great financial unraveling” that has played out since last summer. That unraveling began, of course, with shaky mortgages arranged by unregulated mortgage brokers. Securities linked to those mortgages have now brought down unregulated hedge funds as well as lightly regulated investment banks, prompting widespread calls for “better ways to regulate and police our financial industry.” And U.S. policymakers of all stripes are listening, said Elizabeth Williamson in The Wall Street Journal. Free-market views have long held sway in Washington. Yet suddenly, the mortgage crisis and its fallout “are driving both political parties to reconsider how much companies and markets should be relied upon to police themselves.”

There’s one thing that the Bush administration and Democratic lawmakers can agree upon immediately, said Edmund L. Andrews and Stephen Labaton in The New York Times. “The meltdown in credit markets” exposed troubling weaknesses in the regulation of financial markets and institutions. But not surprisingly, there’s sharp disagreement about how to fix those flaws. Congressional Democrats want to “subject Wall Street firms to the kind of strict oversight that banks have had for decades.” The Federal Reserve already sets stringent limits on the amount of money commercial banks can borrow and the amount of cash they must keep on hand. Wall Street’s investment banks have traditionally enjoyed much greater flexibility. But last week, the Fed took the unprecedented step of allowing investment banks to borrow directly from the Fed on the same terms as commercial banks. If Wall Street is going to benefit from the Fed’s largesse, Democrats argue, it should be covered by the Fed’s rules. But President Bush and Treasury Secretary Henry Paulson “remain philosophically opposed to restrictions and requirements that might hamper economic activity.”

That’s not an economic policy, said Paul Krugman, also in the Times. That’s “willful amnesia.” The Great Depression of the 1930s made it clear that “unregulated, unsupervised capital markets can all too easily suffer catastrophic failure.” Over time, though, we’ve forgotten that lesson and allowed the emergence of “a shadow banking system” that skirts the rules and regulations “designed to ensure that banking was safe.” Now, in an eerie echo of the bank runs of the 1930s, people are “pulling money out of the shadow banking system,” setting off “a vicious circle of financial contraction.” Belatedly, the Fed is doing what it can to “break that vicious circle.” But the Fed’s efforts are only short-term patches. When the dust settles, Washington will have to get to work on wide-ranging, systematic reform. “It’s time to relearn the lessons of the 1930s, and get the financial system back under control.”