But there ARE examples of more regulation equalling less risk. The FDA, ICC, FTC, NHTSA and other federal agencies regulate industries successfully. They introduce standards and transparency that overcomes much fraud, increases public safety, provides legal avenues for consumers, promote growth, etc. Regulation may be risky, but lack of regulation is not risky, it is certainty of systemic failure. The first move, and the the one which would have prevented much of the damage of the current dip, is the repeal of the Glass Steagall Act. Lack of transparency regulation allowed the biggest offenders to hide their faulty activitiies.No, financial regulation is necessary to keep the normal market ups and downs within manageable range.
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Regulating Risk is Risky Business
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The first job of new regulators will be to make certain that financial firms do not become over-leveraged again. This will mitigate the risk of creating derivatives instruments that allow banks and hedge funds to gamble a large portion of their assets without a huge up-front investment. The prevention of excessive leverage will not help predict or prevent the failure of pools of loans like commercial real estate which appears to be the next significant challenge that money center and regional banks face.
Government authority is also unlikely to insist that current lending to consumers should be done with less risk and more care than it is today. Banks may have overextended their exposure to consumer credit and may be paying the price with write-offs. But, what is an appropriate exposure when banks are putting capital in the hands of consumers? Banks will actually have to increase lending to people who want to buy homes or begin to buy cars and other relatively expensive goods and services. The evidence at this point is that banks are "under-lending" to consumers and small businesses, threatening a recovery of national GDP. Regulators who want to restrict lending with moderate risk take on the authority of measuring how much capital should go from private financial institutions into the market of the transactions that feed the economy.
The other significant assumption behind the power of regulating the financial markets is that transactions based outside the US can be moderated by the American government. There are a number of risks involved in transactions with sovereign governments and overseas private businesses. Banks that are counterparties to American international financial firms may assume risks outside the parameters set by a new network of US regulation. A systematic failure of the banking industry could begin outside American borders, but American financial institutions could clearly be hurt badly, with or without government oversight.
The proposal that the Treasury will put before Congress assumes that cobbling together several regulatory agencies to create a small and more powerful set of overseers will somehow make the government's ability to foresee future events better than it is now. There is no historical precedent to indicate that this is true.
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