Obama's Regulation Speech Thin On Too Big To Fail

On the one-year anniversary of the fall of Lehman, the President has decided it might be a good idea to visit New York and chastise Wall Street explain to Wall Street the regulation he believes necessary to avoid another financial crisis. But one area of reform where his speech is disappointing thin is dealing with the too big to fail problem. He has only three talking points that begin to touch on this problem. I'm unconvinced any of them will necessarily solve it.

First, you can find a copy of the full text here. I'm not sure how seriously anyone can take the President's supposed dedication to financial reform, given the low priority it's been given during his first year in office. At this point, he'll be lucky to get it during 2009. And by waiting so long, serious reform has become a more distant hope. In the speech, however, he promises new regulation will still happen by year's end.

Systemic Risk Regulator

The President spends a little time in the speech discussing the creation of a systemic risk regulator. I remain entirely unconvinced that such an authority would have any ability to prevent firms from becoming too big to fail. I'm cynical for two reasons.

First, I don't believe that the regulator will be particularly good at predicting sudden, unexpected risk. If it was, then that risk would be neither sudden nor unexpected.

Second, such a regulator might just function to bail out or prop up firms that should be failing, instead of actually fixing the problem. In the past I've expressed my fear that this is exactly what we'd get if the Fed is chosen as this regulator.

Higher Capital Requirements

Another proposal the President mentions is to increase capital requirements for banks, especially big ones. He says this should happen both in the U.S. and abroad. He says:

We'll also require these financial firms to meet stronger capital and liquidity requirements and observe greater constraints on their risky behavior. That's one of the lessons of the past year. The only way to avoid a crisis of this magnitude is to ensure that large firms can't take risks that threaten our entire financial system, and to make sure they have the resources to weather even the worst of economic storms.
For we know that abuses in financial markets anywhere can have an impact everywhere; and just as gaps in domestic regulation lead to a race to the bottom, so too do gaps in regulation around the world. Instead, we need a global race to the top, including stronger capital standards, as I've called for today.

I've extolled the virtues of this idea already, so I won't spend much time on it again here. It doesn't, at all, solve the too big to fail problem. It indirectly refers to it, however. Forcing bigger banks to have higher capital requirements merely attempts to lessen too big to fail's blow to competition by leveling the playing field. It's better than nothing, but it's no where near ideal.

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.

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