Courtesy of This is something I did for the The Hearing blog at the Washington Post:
Making Financial Regulation Work: 50 More Years, by Mark Thoma: Banking regulation imposed in response to the Great Depression and the recurrent panics of the 1800s and early 1900s gave us 50 years of stability in the financial system without impeding economic growth. That’s quite a record to overcome for those who say regulation does not work.
But the stability began to break down with the savings and loan problems in the 1980s, and the growing instability since that time is evident in the severe meltdown we are experiencing today.
What happened? Deregulation beginning with the Reagan administration combined with financial innovation and digital technology led to the emergence of what is known as the shadow banking system. These are financial institutions that, for all intents and purposes, function just like banks but are not subject to the same rules and regulations and, in some cases, are hardly regulated at all.
The development of the shadow banking system is important because the troubles we are seeing today are not the result of problems in the traditional, regulated sector of the financial industry. The problems began in the unregulated shadow banking system.
We need to bring the shadow banking system – essentially any institution that takes deposits and makes loans either directly or indirectly – under the same regulatory umbrella as the traditional banking system.
What type of regulation should we impose to give us the best chance of achieving another 50 years or more of relative calm?
Initially my concerns were with the economic issues, and the focus was on designing a regulatory system that would overcome the market failures that led to excess risk-taking and to institutions that were too big and too interconnected to fail.
But large financial firms exert more than their share of political power, and this adds another dimension to the problem. Banks that are too big and too interconnected to fail pose an economic risk to the overall economy. However, firms can also be "too big for politicians to ignore." When this happens, they can exert undue influence on legislation or capture
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