With Congress expected to debate financial regulatory reform until the cows come home, lots of commentators are weighing in on what it must do to inhibit, if not prevent, an even worse financial meltdown. (And no, we aren't out of the woods, not by a long shot.)
Our own Marine Cole ventured into these waters last week with a piece on to what degree legislation as currently formulated would require bank regulators to toughen their capital reserve requirements. But there's a lot more to say about that, too much.
Suffice it for me, then, to point to a couple of good posts in the blogosphere on the topic in the past few days. One is at the Baseline Scenario, where James Kwak usefully explains that Paul Krugman created a false dichotomy last week when he argued that the size and scope limits on big banks known loosely as the Volcker Rule wouldn't address systemic risk posed by a lack of regulation. As Kwak points out, the Volcker Rule and tough regulation are hardly incompatible. To the contrary, they're both necessary.
And at Interfluidity, Steve Randy Waldman takes the point a big, big step further by describing why capital requirements are far more likely to be ineffective than structural changes along the lines that Volcker proposes.
Indeed, Waldman cites the Lehman meltdown as proof positive that capital requirements are meaningless for complex financial institutions. In a nutshell, they cannot help but be gamed when an institution relies on structured debt to fund its operations. For better or worse, the capital of a complex bank is a confidence game.
As damning as the Valukas report on Lehman was, it did not dispute the bank's contention that is capital was sufficient days before it melted down.
So we're left ultimately with the structural changes that Volcker is seeking , along with efforts to curb speculation in opaque instruments like OTC credit default swaps.
The only question is how hard the Obama administration will push for those. If Volcker had his druthers, the administration would go more or less all out. But Volcker is not Larry Summers or Timothy Geithner.
And as Kwak handicaps the current political scenario, Volcker may be no match for Summers, Geithner and other "moderate" Democrats, and of course Tall Paul can expect no help whatsoever from today's GOP.
So much for the man everyone once hailed as the greatest Federal Reserve chairman since Marriner Eccles.