It now seems universally accepted that government should establish the structure and rules for the financial system, with participants then pursuing their self-interest within that framework. But in a complex system in which expertise, insight, and real-time information are widely dispersed – and trust is lacking – reliance on such a framework seems deficient and unwise.
MILAN – Around the world, the debate about financial regulation is coming to a head. A host of arguments and proposals is in play, often competing with one another – and thus inciting public and political confusion.
One approach to financial re-regulation – supported by arguments of varying persuasiveness – is to limit the size and scope of financial institutions. Some claim that smaller entities can fail without impairing the system, thus sparing taxpayers the cost of a bailout. But if systemic risk emerges in ways that are not yet fully understood, smaller banks may all fail or become distressed simultaneously, damaging the real economy.
A second, hotly debated argument is that limiting banks’ size and scope has relatively low costs in terms of performance. This point is used to bolster a third argument: large institutions have undue political influence and thus “capture” their regulators. Put bluntly, large and profitable financial institutions will find a way to get the regulatory system they want – one that is compatible with a highly profitable trading super-structure that goes beyond the requirements of hedging and seeks to maximize short-term gains.
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