Matt Zeitlin: Impetuous Young Whippersnapper

If the huge blow up in the financial sector has shown us anything, it’s despite the protestations of those on Wall Street and their allies in the government and press, much activity in finance has zero-t0-negative social value. Sure, naked CDS trading can enrich banks and traders (for a while anyway), but it’s hard to say exactly how society benefits from it. But just because certain activities have little (or, in the long run) negative social value, that doesn’t mean they shouldn’t happen at all, but just that government should take steps to mitigate their long run negative impact and certainly shouldn’t encourage the proliferation or expansion of these types of activities.

So, looking forward to how we want to regulate the financial sector, a few things seem obvious.

One, impose a simple rule on financial institutions. Either, you can be big — so big that your insolvency would threaten the collapse of the world economy — and not do anything risky or you can be small and do whatever the hell you want. Another way to thread the needle here would be to require banks like Citigroup, or anything that’s “too big too fail,” to pay into a super-FDIC, essentially to buy bailout insurance, so that if and when they need to be bailed out, it’s not a huge, sudden expense on the taxpayer. Or you simply let hedge funds do all the exotic stuff and tell banks to, well, be banks. Or, hell, you could just not let financial institutions get too big. For example, you could say that investment banks have to be partnerships and not let them become publicly traded companies (and thus get so big) or, on a smaller scale, just limit how much leverage can be used.

The point is not that x,y or z regulation should be adopted, but simply that if you approach financial regulation from the perspective of “what are simple rules would we adopt if we assumed that only some financial activity had a positive effect on social welfare (meaning that simply enriching already rich people wouldn’t count)” then a whole lot of ideas come to mind that are pretty different from what we had before.

Politically speaking, if we’re going to actually implement any of these  reforms, we would have to do it pretty soon. That’s because, as evidenced by the last ten or so years, financial institutions can make a lot of money doing stuff that doesn’t really benefit anyone besides themselves (and pose a risk of destroying the global economy) and so all the smart people go into finance instead of regulating and financial institutions can effectively lobby the government to not adopt any of these regulations. We have to get them while they’re down.