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Left-Right Convergence on Financial Reform?

It might be time to break up the banks.

9:37 AM, Apr 6, 2010 • By MATTHEW CONTINETTI
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Left-Right Convergence on Financial Reform?

What Would JP Do?

Before you hit the snooze button, I want to point out a fascinating debate that's taking place over financial reform. Here's where we stand. The House passed its bill in December. The Senate recently passed its bill out of committee, and it now awaits a floor vote. Two weeks ago David Leonhardt had an easy to read rundown on the issues. The package has five main components: resolution authority to take over insolvent investment banks, a Consumer Products Safety Commission, higher capital requirements, the bank tax to "pay for future bailouts," and the Volcker Rule banning banks from trading for their own benefit, not their customer's.

One unresolved issue is whether the government should break up the big banks so that institutions no longer become Too Big To Fail. This is the position advocated by economists Simon Johnson and Robert Reich on the left, and Arnold Kling and others on the right. Over the last week, however, Paul Krugman has written two columns saying the size of the banks is irrelevant; what matters are the rules the government sets for the banks, and how well the government enforces those rules. (As an aside, my favorite line in these Krugman pieces is when he says that financial reform is "not like health reform, which was fairly straightforward once you cut through the nonsense. Reasonable people can and do disagree about exactly what we should do to avert another banking crisis." So you see, anyone who disagrees with Krugman on health care is insane.)

Economically, Krugman has a point: you can still get bank runs and financial panics when banks are small. But what about politics? The point of keeping the banks small is to not let any one bank or group of banks amalgamate too much power. That was the point of Johnson's famous Atlantic essay on the financial crisis, in which he wrote that the big bankers constitute a sort of oligarchy influencing policy behind the scenes and structuring bailouts to their liking. AIG, Fannie and Freddie, and the auto unions all have political pull that direct public money to private profit. When bankers have too much power, they will be able to capture the regulatory institutions and limit surveillance. They will be able to game the system so that the rules Krugman champions won't be enforced.

Why not limit the size of banks while policing their behavior? It's not an either/or issue. Do both.

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