Monday, March 23, 2009

Financial Regulation

I'm somewhat perplexed by this blog post by Richard Posner on financial regulations. Posner argues that there should be no new financial regulations until the current recession has bottomed out. There is a basic intuitive support for this argument in that additional regulations could limit risk-taking and drive up the cost of lending at a time when the federal government is desperately trying to encourage new lending. But Posner's position is focused primarily on uncertainty in the marketplace. He writes:
Any regulatory initiatives at this time will simply increase the already great uncertainty in which the financial industry is operating; and as Keynes pointed out, anything that increases uncertainty in a depression causes hoarding, which can in turn precipitate a deflation likely to deepen and protract an economic downturn.
His point is well taken, but I think he gets the matter of uncertainty backwards. The uncertainty Posner appears to be worried about is already priced into the market. The one thing that investors are not uncertain about at this point is that there will be new financial regulations. I don't think anyone doubts that at this point. The uncertainty is about what those regulations will be. The sooner the government can spell that out, the sooner this uncertainty will be diminished. The additional benefit is that the financial crisis has severely undermined public confidence in the banking system, and if the new regulations are well-crafted (or at least are broadly perceived to be), they can begin to restore some confidence. And in any case, when it comes to the Obama administration and Democratic congressional leaders, all of these concerns may be secondary to the fact that there is huge public support for financial regulations at present, leading to a desire to strike while the iron is hot.

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