The one thing we know about the financial “reform” now moving toward what looks like eventual congressional approval is that it will be oversold, says economist Robert Litan of the Kauffman Foundation. We will be told that it will forever prevent a repetition of the recent financial crisis; that it will root out corruption on Wall Street; that it will eliminate “bailouts”; that it will protect consumers against greedy lenders. In the present anti-Wall Street mood, no one wants to be accused of coddling America’s money merchants.
What can we really expect?
History counsels caution. Every financial reform, even if mostly successful, ultimately gives way to another because there are unintended consequences or unforeseen problems. Sheila Bair, the head of the Federal Deposit Insurance Corp., has noted that the reforms of the early 1990s, which curbed risk-taking within the banking system, perversely shifted lending to the largely unregulated “shadow banking system” — mortgage brokers, specialized lenders and “securitization.” The central aim of today’s reform is to avert another financial panic. A panic is not a bubble or just big losses. These are inevitable and, in part, desirable: Without losses, investors would become reckless. A panic is a stampede of selling and hoarding, driven by fear, that threatens the financial system and, through it, production and jobs. A panic occurred in September 2008 when Lehman Brothers failed. Distrusting most financial institutions, investors and money managers fled to safety (a.k.a. Treasury bills).
By its nature, a panic is unanticipated. Reform may resemble generals fighting the last war….