Bankruptcy

Future of Bank Regulation: GSE-lites?

By Adam Levitin

Two possible directions are possible in banking regulation: a move to universal banking, in which there is no distinction between commercial banking, investment banking, and insurance (much like in Germany) or a return to the stricter divisions of Glass-Steagall.

It looks like we're headed toward the former, as the major investment banks have either failed, been acquired by commercial banks, or converted into bank holding companies. Likewise, we've seen huge consolidation among commercial banks. With Citi swallowing Wachovia and JPM gobbling up WaMu, it looks like the financial services industry will be dominated by 3 large institutions, BoA, JPM, Citi, maybe joined by Wells Fargo, and then a bunch of smaller hoi polloi. The three behemoths will be too large to fail, so there will be a more stringent government oversight regime. In fact, they will be quasi-governmental instrumentalities in practice, even if legally separate.

Does this sound familiar? When the dust settles, I think BoA, JPM, and Citi will look a lot like Fannie and Freddie--dominating their industry, too large to fail, under close government oversight. If this is the route we are heading, let's be clear about it and adopt a regulatory scheme that learns from Fannie and Freddie's problems. Perhaps the first lesson is "too large to fail is not good." But it appears that we are going to ignore this lesson. The second lesson then, is one we should take to heart: when entities are too large to fail, they need strict regulatory scrutiny and should be prohibited from lobbying. Lobbying is a method to avoid regulatory scrutiny, and Fannie and Freddie's lobbying machine was very successful at that. Any regulatory regime for too-large-to-fail universal banks needs to account for the anti-regulatory impulse in bank lobbying.

Full post as published by Credit Slips on October 01, 2008 (boomark / email).