Paul Krugman: Breaking Up the Big Banks Does Not Go Far Enough

Paul Krugman illustrates why financial regulation needs to go way beyond breaking up big banks in Monday's column, and how fragile the small fixes made after the last crisis really are. 

His main topic is a recent terrible ruling in a case involving insurance giant MetLife allowing it to get around some regulations imposed on it after the crisis of 2008.

First he offers some background:

When catastrophe struck the troubled U.S. financial system in September 2008, the proximate cause was the looming collapse of three companies — none of which were banks in the normal sense of the word, that is, institutions that take deposits and lend them out. One of them was, of course, Lehman Brothers; the other two were The Reserve, a money-market fund, and American International Group, or A.I.G, an insurance company.

Lehman declared bankruptcy, while The Reserve, which had lost money with Lehman, froze customers’ accounts, and was eventually forced into liquidation. A.I.G. was rescued by an $85 billion credit line from the Federal Reserve; in return, the Fed took 80 percent ownership of the company.

The episode showed that traditional financial regulation, which focuses on deposit-taking banks, is inadequate in the modern world. It’s not just that anyone who borrows short term to finance risky investments — which is what Lehman did — creates the same kind of danger as a conventional bank. There’s also a high degree of interconnectedness: A.I.G. wasn’t a bank, but it was selling guarantees on financial assets, and fears that it might fail to honor those guarantees threatened to topple dominoes across the economy.

The financial reform enacted in 2010 attempted to limit the risks from non-bank institutions by allowing regulators to designate some institutions as “systemically important,” according to Krugman, "meaning that, like A.I.G., their failure or the prospect thereof could threaten financial stability. Once an institution is so designated, it is subject to extra oversight and regulation."

MetLife received that desgnation in 2014, and decided to challenge it in court. Rosemary Collyer, a Federal District Court judge, ruled in the insurance giant's favor, a ruling that Krugman describes as "peculiar." And that is putting it nicely.

The Feds are appealing, but Krugman sees signs of a bad wave of lawsuits of companies challenging reform and regulation. 

It's another way in which having a Democrat in the White House vs a Republican would yield stark and potentially catastrophic differences since Republicans would almost certainly do everything in their power to undermine the regulations put in place, inadequate as they might be.

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