Responding to Obama on Financial Reform

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President Obama offers powerful rhetoric but weak proposals.  The financial Humpty-Dumpty of big inter-linked banks, securitized mortgages, and self-defeating housing and bank capital regulation policies has had a big fall.  The Administration's response amounts to putting this Humpty-Dumpty back together, taping on some new regulations, and sticking it back on the wall.  That is not the answer.


Instead, we need new directions.  We need housing policies that don't equate affordable housing with subsidized, lenient mortgage credit.  We need to disconnect the mortgage-backed securities market from the feeding tube of government support.  We need to put an end to too-big-to-fail, too-connected-to-fail, and to too-regulated-to-fail.  Too-anything-to-fail is self-defeating, because it only encourages excessive risk-taking.

Instead of too-regulated to fail, we need to make failure a credible and viable option for financial institutions.  We need business continuity that ensures that everyday financial transactions will continue when a bank fails, no matter what the size.  We should have procedures and emergency response teams in place, so that we can swoop in the day that an institution fails and ensure that the next morning the ATMs work, checks can clear, and transactions on credit cards and debit cards can be processed.  But we will not see prudent financial behavior unless we can convince bankers that we have a viable and credible option of allowing them to fail.

I will have more to say on Tuesday here.

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Arnold Kling

Arnold Kling earned his Ph.D in economics at MIT. He was an economist on the staff of the Federal Reserve Board. From 1986-1994 he worked at Freddie Mac. He started Homefair.com in 1994 and sold it in 1999. His fourth book, From Poverty to Prosperity, co-authored with Nick Schulz, is due out in April of 2009. He blogs regularly at Econlog.
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