Holding Wall Street Accountable Your Wallet Hostage
Right now, our country is in the process of passing legislation that many see as badly needed reform in the financial industry. The reform comes as a reaction to the most recent banking crisis, which sent the world economy into a tailspin.
As we climb our way out of this recession, the last thing we need is monetary policies that would stagnate private capital flow. The second-to-last thing (but if anyone would like to convince me it should at the top of my list, I’d be willing to listen) we need is a rise in the costs of necessary consumer products. Financial products like savings and checking accounts exhibit relatively inelastic demand trends, which gives the producers of those products, the banks, better pricing power. If the proposed regulations are enacted, financial institutions across the nation will incur new costs. My bet is that at least a substantial proportion of those costs won’t come out of their profit margin — they will come out of our pockets.
A recent article in the St. Louis Beacon debates the pros and cons of the proposed regulations. In the article, Dr. Joseph Haslag, the Show-Me Institute’s chief economist and an economics professor at the University of Missouri–Columbia, points out that the proposed regulations miss the mark.
“It’s not the derivatives or the swaps or any of the other complicated financial contracts that are problems by themselves,” said Haslag, who holds the Kenneth Lay chair in economics at Mizzou. “They are mechanisms that parcel out risk. People see these as ways to make big gambles, and there are risks in the world. If you line up your gambles all in one direction, and the risks come out in a certain way, you can lose a lot of money.”
As people in the finance industry seek to maximize their profits, they will find ways around the new regulations. It may very well be the case that these regulations force bankers into even riskier behavior that is outside the scope of presently foreseeable action. The government has no way of knowing or policing the instruments that may be developed next. In fact, by mandating this type of regulatory environment they might very well cause a new variant of the type of behavior they were trying to quash.
As regulatory protocols are activated, the banks with the best chance to survive the rough waters are the the same banks that were implicated in the financial crisis in the first place. On the other hand, small community banks that keep capital localized will have a tough time staying afloat. This is all trouble for consumers.
Yesterday, the Wall Street Journal ran a piece titled “The End of Community Banking. From the article:
What does all this mean for our customers? Less credit will be available, costs will increase, and we will be less able to make loans to regular people who were creditworthy in the past. This is the perfect storm for the small retail banking customer.
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Small community financial institutions care about the people in their communities. Unfortunately, the new financial regulatory reform bill will greatly inhibit our ability to help them.
If your post contained any specific argument about a specific part of this bill, then I would see a lot more value here. As it is you’re just making the argument “more regulations are bad” and not making any more nuanced statement about what they are and how they operate.
Comment by Eapen Thampy — July 1, 2010 @ 3:23 p.m.
This is a blog post, not a research paper. The point is sometimes to make you think. Yes, some regulations are useful and increase efficiency because of increasing returns or asymmetric information.
As a first-order effect, these regulations raise the cost of producing intermediation services. As the marginal cost rises, the equilibrium return on deposits decreases. It follows that the price of future consumption is higher. Based on this analysis, the argument is that regulation produces a welfare-lowering effect. I agree it deserves a model economy to assess whether there are efficiency gains that go with the specific types of regulations proposed. But I do not see where the Congress or the current Administration has developed that model and thus shown me where those efficiency gains lie.
You are an MU economics student, please be curious.
Comment by Joe Haslag — July 2, 2010 @ 1:51 p.m.
My point is that the bill (as I’ve see) contains several types of regulations and that a simple claim that they’re all bad isn’t very helpful. I also think of blogging as part of a continuum of scholarship and it is certainly the case that it is presented as such.
I often think of financial innovation as a tax on consumers who are not able to understand opaque financial products. Consider that many financial products that emerged over the last 10-15 years were sold as instruments that were similar to simple financial instruments but that held hidden risks. Because the risks were hidden by the complicatedness (as distinct from complexity) of these instruments, they were attractive to consumers.
I think it would be far more useful to distinguish the parts of this bill into portions that are valuable in regulating out the lemons, and those that are not.
Comment by Eapen Thampy — July 3, 2010 @ 8:34 a.m.
In any case the bill, as i understand it, increases the capital requirements of institutions making big bets and creating complicated financial instruments. Additionally, it segregates investment activities from other banking activities.
Perhaps banks will be able to successfully arbitrage around these regulations, and that’s an endemic concern. It is important to realize that this kind of arbitrage may not be predictable, as Josh notes, but as a corollary that means that we need incentive compatible structures for regulators to operate under. Rating agencies for instance should operate under structures that don’t incentivize them to optimistically rate (lemon) securities.
Comment by Eapen Thampy — July 3, 2010 @ 8:38 a.m.
All that the financial reform bill tries to do is what the Wall St people should do on their own: be honest about what they are selling, and don’t run around the country selling risky investments to unsuspecting people. Wall St. has been pulling huge sums of money out of the economy for years, and the competitive market has not worked. Theoretically, Wall St firms should compete on fees by lowering the excessive bonuses paid. But somehow the competitive system is not working there
Comment by dempster holland — August 8, 2010 @ 10:56 a.m.