On June 17, the Treasury Department issued an 88-page report entitled Financial Regulatory Reform: A New Foundation: Rebuilding Financial Supervision and Regulation. The Report (as I’ll call it) is a blueprint for reform of financial regulation, with the aim of preventing another financial crisis. In this first part of a two-part article, I discuss weaknesses in the overall approach that the Report takes to the problem of reform, as well as weaknesses in the Report’s proposals for limiting “systemic risk.” Part II (which will be published on FinReg21 on August 3) will discuss the proposals concerning executive compensation and consumer and investor protection, and will also suggest some alternative proposals for regulatory reform.

The Report’s fundamental weaknesses are its prematurity, overambitiousness, reorganization mania, and FDR envy. Let me start with the last. It is natural for a new President, taking office in the midst of an economic crisis, to want to emulate the extraordinary accomplishments of Franklin D. Roosevelt’s initial months in office. Under Roosevelt, within what seemed the blink of an eye, the banking crisis was resolved, public-works agencies that hired millions of unemployed workers were created, and economic output rose sharply. But that was 76 years ago. The federal government has since grown fat and constipated. The program proposed in the Report cannot be implemented in months or years, or perhaps even in decades—as would be apparent had the Report addressed costs, staffing requirements, and milestones for determining progress toward program goals and had the Report attempted an overall assessment of feasibility.

The Report is premature in two respects. The first is that it advocates a specific course of treatment for a disease the cause or causes of which have not been determined. Now it is not always necessary to understand the cause of something you don’t like in order to be able to eliminate the effect. If you have typical allergy symptoms you may get complete relief by taking an antihistamine; it is not necessary to find out what you're allergic to. But generally, and in the case of the current economic crisis, unless the causes of a problem are understood, it will be impossible to come up with a good solution. The causes of the crisis have not been studied systematically, and are not obvious though they are treated as such in the Report. (Remember, the Great Depression of the 1930s ended 68 years ago and economists are still debating its causes.) We need some counterpart to the 9/11 Commission’s investigation of an earlier unforeseen disaster.

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