Krugman: Financial Reform Needs Harsher Bite

Thursday, 15 Apr 2010 08:29 AM

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How good is the financial reform legislation presently on the table? Not very, says economist Paul Krugman, who believes bill falls far short of what it needs to be.

"It's a good-faith effort to do what needs to be done, but it would create a system highly dependent on the wisdom and good intentions of government officials," Krugman says.

"And as the history of the last decade demonstrates, trusting in the quality of officials can be dangerous to the economy's health," he recently wrote in The New York Times.

Krugman acknowledges the impossibility of devising a truly foolproof regulatory regime.

“Anyone who believes otherwise is underestimating the power of foolishness,” he says. “But you can try to create a system that’s relatively fool-resistant. Unfortunately, the Dodd bill doesn’t do that.”

The problem of “too big to fail” has gotten most of the attention, Krugman notes — and while big banks deserve all the contempt they’re getting, the core problem with our financial system isn’t the size of the largest financial institutions.

“It is, instead, the fact that the current system doesn’t limit risky behavior by ‘shadow banks,’ institutions — like Lehman Brothers — that carry out banking functions, that are perfectly capable of creating a banking crisis, but, because they issue debt rather than taking deposits, face minimal oversight,” Krugman says.

The Securities and Exchange Commission has announced it has begun an inquiry into two dozen financial companies to determine whether they followed accounting practices similar to those recently disclosed in an investigation of Lehman Brothers, The Christian Science Monitor reports.

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