The Financial Times has a debate over recent Congressional attempts to loosen bank regulation. Hal Scott supports looser regulation:
The Fed’s stress tests are effectively the binding constraint on bank capital and thus lending. They require banks to prove they could survive extreme adverse scenarios while still complying with global capital requirements. The process has two major deficiencies.
First, the Fed’s adverse scenarios are extreme to the point of incredulity. For example, the latest stress test assumes an increase of the unemployment rate from 4.1 to 10 per cent over seven quarters. That has not happened in the 70 years since today’s measure for unemployment was adopted. There is no open consultation with experts, industry or the general public as to whether these scenarios make sense.
Do we really want banks to hold enough capital to survive events that have no US historical precedent? If such an extreme economic event did occur, would any amount of capital be enough to withstand the panic it could trigger?
We absolutely do want to have banks be able to survive a recession that pushes unemployment up to 10%. The unemployment rate hit 10% in 1982 and again in 2009 (albeit from a higher base than today.) In the early 1930s, it rose from 3% to 25%. After what happened in 2008, how can anyone seriously claim that we don’t want our banking system to be able to survive a recession that leads to 10% unemployment? That makes no sense.
I don’t know enough about bank regulation to have an informed opinion on stress tests, but this argument actually makes me more likely to support the other side. I didn’t even have to read the arguments made by Lisa Donner, in opposition to loosening regulations.
Ideally we’d have a laissez faire banking regime. But until we get rid of the GSEs, FDIC and TBTF, we probably need some sort of capital requirements and/or stress tests. Since neither party favors removing moral hazard from banking, we are unfortunately stuck with regulation.