Thinking about Saturday's blog on the importance of regulating the financial industry intelligently, I re-read The Squam Lake Report today. Published last year, it helped inform the debate on the Dodd-Frank debate by summarizing a conference of fifteen of the nation's leading economists in Squam Lake in New Hampshire. If there is a partisan bias in their discussion, I cannot detect it. My belief is that it is the honest recommendations of nerdy economic academics.
Some of their recommendations are interesting by what they leave out. There is no recommendation for a Consumer Financial Protection Board, which seems to be the heart of Republican opposition. But, there is a strong recommendation for a systemic regulator, which has been done in name only. Currently, regulation is aimed at individual institutions, not the system. They also recommend large financial institutions maintain a "Living Will" with regulators giving suggestions on how to take over each particular bank more favorably. This arises from a conclusion that the liquidation of Bear Sterns and Lehman was done so poorly that it made the crisis worse. This was also not done.
My primary interest was their recommendations on improving the "information infrastructure." Not only do regulators need more and better information but also other financial institutions that do business with each other need even better information. This is called counterparty risk. You don't trade with another bank unless you are sure they are strong enough to pay their obligations. I know many analysts argue bank stocks are cheap, and they are right. But, I still think there is a hidden systemic risk that I will avoid.
They identified the single most important information needed was about derivatives, which I've been saying for years. As the elected children in Congress try to preserve their election chances, I hope they leave this portion of the Dodd-Frank bill as it is. Are you listening Senator McConnell?
