A New Regulatory Tool for Financial Stability

Economists tend to be pretty good at pointing out what is currently going wrong with the economy. But we tend to be rather hamstrung at offering solutions. In the current crisis, public policy needs to achieve three things: 1) help troubled homeowners and declining communities, 2) maintain liquidity and stability in the credit market, and 3) prevent another financial crisis of this magnitude from happening again. Lawyers, community activists, consumer advocates, sociologists, among others, have offered a wide array of proposals to address the first two problems. Little has been suggested in ways of addressing the chance of a repeat crisis in the future. Economists in particular are reluctant to go beyond simple proposals that call for more market transparency. A changed regulatory, environment, though, may help to reduce the chance of future financial crises. Specifically, a few economists have proposed a new regulatory tool called asset-based reserve requirements for more than three decades. This tool would allow the regulatory agency, often assumed to be the Fed, to force financial institutions to bear the cost of their investment decisions and not to unload them onto society.

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This article was originally published in Credit Slips.