Academic

Two other papers at Friday's Financial Institutions Section focused on bailout policies. Jeff Gordon (Columbia) presented a paper advocating expanding and specifying the crisis resolution powers of bank regulators. He argued that specifying these powers avoids the risks he saw in the current with regulators having unclear authority and having to ask Congress for more in the midst of a meltdown. Gordon outlined proposed mechanisms to address the ?democracy deficit? in giving regulators a great deal of power, including requiring a multiple key system in which several regulators would need to agree before certain emergency powers can be exercised.

Julie Hill (Houston) followed with a paper ?Bailouts and Credit Cycles: Fannie, Freddie, and the Farm Credit System.? Hill compared the history of Freddie and Fannie?s creation and bailout with that of another government-sponsored entity ? the Farm Credit System. She noted that Fannie and the Farm Credit System were in essence created to bail out different collapsed credit markets in the wake of the Great Depression. She then examines how regulators can make theses GSEs act more countercyclically ? that is lend less and be more conservative in boom times and extend more credit in the bust. Hill came to the surprising conclusion that bailouts are a necessary tool in the countercyclical kit.

Both provocative proposals ultimately raise the inevitable tension between crisis management policies and crisis prevention. Most often this is framed as moral hazard for firms that can be bailed out. To some extent moral hazard can be mitigated if the details of the bailout impose pain on both shareholders and creditors of bailed out firms. But bailout regimes also demand effective regulation to prevent crises.

It was enjoyable to hear Jose Gabilondo (Florida International) and Anna Gelpern (American) comment on these two papers, particularly since they have experience working in the public and private sectors on financial crisis management. A few of their comments stuck in my head. On the re-discovery of the importance of economic cycles in the economy, Gabilondo cite an old Schopenhauer quote:

All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident.

Gabilondo also asked whether this is the moment for macroeconomists to reassert their critical role in designing financial institution regulation after what he perceives as a period of dominance by microeconomists.

Gelpern echoed this and suggested that legal scholars pay heed to developments in macroeconomic and political science literature. She argued legal scholars must play a key role in defining what is meant by one of the hotter ideas in financial regulation (which has also followed the Schopenhauer progression): ?macroprudential? regulation ? or financial regulation that focuses not just on the financial health and risks posed by individual firms, but on the entire financial system as well.

To bottom line it: financial regulation scholars will be puzzling through "countercyclicality" and "macroprudential" regulations for a while and there need to be more conversations with macroeconomists and consideration of political economy to boot.  Simple, right?