Wallison on fiscal regulation

Peter Wallison has an of import Op-Ed inward the Wall Street Journal last week (AEI link) titled "Dodd-Frank together with the Myth of Interconnectedness"

The chain of bankruptcies is 1 of the fundamental myths of the fiscal crisis. H5N1 owes coin to B ,  B owes coin to C , C owes coin to D. If H5N1 fails , it wil effect in a chain of bankruptcies where B , C ,  together with D neglect too.

As Peter points out , it exactly did non happen. We had a run , non a chain of bankruptcies.
A (L actually!) failed , investors noticed that B , C and D were invested inward many of the same things , together with stopped lending to B , C together with D; B , C  and D also stopped lending to each other. Everyone tried to purchase Treasuries. Since the banks were funding themselves yesteryear overnight debt , they were supremely exposed to such a run.  

Getting it incorrect matters. To gain a sensible rule of the fiscal organisation , it helps to bring a vaguely coherent thought of what happened -- together with what did non happen. The Dodd-Frank/Fed approach seems to live "we don't know what happened , genuinely , so we'll exactly regulate everything that moves."

On the chain of bankruptcies theory , and every bit directed by Dodd-Frank , the Fed is getting create to monitor together with regulate all links betwixt "systemically important" institutions , together with implement regulatory limits on their cross-exposures. I reviewed  this inward an before WSJ oped , together with pointed out how fairly hopeless the examine is.

The fundamental thought of Dodd Frank , which the Fed is forthwith endorsing together with implementing , comes downwardly to this:  no "large ," "systemically of import ," "interconnected ," or whatever (nobody knows what these words mean) volition live allowed to fail. The Fed volition live looking over their shoulders the whole time.

That approach will necessarily mean protecting them from competition. How else gain yous brand certain they're "strong ," together with volition never become far trouble? And it's exclusively a affair of fourth dimension that "policy goals" larn enmeshed alongside "regulation." See concluding week's understanding whereby banks agreed to lower primary amounts on 1 grouping of homeowners , every bit "settlement" against their paperwork problems alongside roughly other completely unrelated group. The Fed is pushing difficult for banks to "do more" for housing... yous tin encounter where this volition become fast. 

If , instead , nosotros had a run , every bit I together with Peter believe , that sends yous thinking inward a completely contrary direction. In my persuasion , it agency nosotros ask to larn rid of the institutional focus -- protecting specific "systemically important" institutions -- together with instead focus on the run-prone assets. Peter seems to lean to a greater extent than to the "common shock" problem. But either draw of piece of job of thought is a long manner from what's going on inward the dungeons of the Fed.