Instead, if you think in terms of "how can we optimally regulate so that banks have only incentives to do great things and no incentives to take excess risk," you are on the wrong track.

From Arnold Kling, who argues that if you cannot imagine a world without deposit insurance -- and he doesn't -- then you have to have a world without big banks. Our experience with private deposit insurance so far has been miserable, as the fate of state deposit insurance funds in the S&L crisis made clear. Nobody has deep enough pockets. If banks can constantly game the system once they hit a certain size, perhaps you just can't let them be that size.

Simon Johnson seems to think you can just cut out all the bad things banks can do and make them just do the unrisky stuff. But didn't we try that with Glass-Steagall? How do we really think we can put the genie back in that bottle?

Wish I had time to think more about this, but grading continues for hopefully only another 24 hours. More when I can. In the meantime, please read back on "the regulatory dialectic".

P.S. I was going to give this to Alex Tabarrok's post on setting a carbon tax that varies by temperature when I started writing it this morning. Worth your time.

Labels: banking, economics