More Financial Market Regulation?

Now that investment banks are borrowing from the Fed via the TSLF, many are calling for increased regulation of these companies. Austan Goolsbee, an economic advisor to Barack Obama recently said:

"If you can borrow money from the U.S. taxpayer at a moment of crisis, that is a very sacred insurance policy underwritten by the U.S. taxpayer," said Mr. Goolsbee in an interview last week with Dow Jones Newswires. "We have the right to oversee anyone who is accessing that insurance policy."...

The problem, as we found out with Sarbanes/Oxley, is that the manner of the regulation matters a great deal. From Megan McArdle:

When I try to get people to specify, beyond those four rather anodyne suggestions, we should do, there's a lot of hemming and hawing. Even the left-wing think tankers sort of look at their shoes and whisper "We need a better regulator". At which point even the left-wing journalists in the audience start asking "Where are we going to find regulators who understand this better than the guys at Goldman Sachs--and are willing to work for, say, a GS-13 salary?" The only people who confidently state that they have a surefire master plan to fix the problem are, not to put too fine a point on it, morons with very limited understanding of financial markets. These people generally start by talking about how the Bear Stearns crisis can really be traced back to the repeal of Glass-Steagall, then almost immediately reveal that they know nothing of Glass-Steagall other than its name.

I have tried all sorts of ways to ask these questions. Nor am I engaged in "libertarian gotcha"; though the game is hours of fun, I am not actually against better or even more regulation of investment banks*. I just want to know what sort of regulation we are going to have; I am against doing something for the sake of doing something.

Which financial instruments should be illegal, I ask, but few are willing to name one. How should we arrange the orderly winding-down of an investment bank with complicated business lines and massive counterparty exposure? Rueful shrugs. What business lines should investment banks be forced to divest? Ummm . . . . Should we limit the percentage of a market that one bank can control, at the risk of lowering liquidity in ordinary times? Welllllllllll . . . Should banks have broader distribution of their capital across business lines, or fewer business lines, and is either even possible to arrange without financial disaster . . . good question. Do we give the regulator broad powers, to make them more flexible, or narrow powers, to make them more accountable? Let me think about that . . .

I tend to agree that if the investment banks have access to the discount window, they should be regulated more tightly. But if we tie them up with too much regulation, we are limiting access to capital which could have much wider implications for the economy. I don't have an answer to this one, but I fear that whatever Congress comes up with will be much more onerous than necessary.