Financial Reform 101 - Solving the Root Cause of the Financial Crisis

Krugman begins the discussion concerning Financial Reform. There are essentially two positions. Simply put, one solves the problem of the bailout and the other actually attempts to solve the root cause that led to the finical crisis itself.

To me what is so curious is that smart people still have such terrible problem solving skills. The root cause of the finical crisis was not that we bailed out the banks but that the financial system fell apart in the first place.

The two sides of the debate are on the one hand the "too big to fail" side of the debate and on the other hand, the "finical regulation" side. The two big to fail side considers that if these banks weren't so big then their failure wouldn't be so great and therefore we wouldn't have to bail them out. This approach is like saying, "if there were more small stores selling triple cheese burgers instead of one big triple cheese burger big box, then there wouldn't be an obesity problem" The problem is not triple cheese burgers its the size of the cheese burger stores. Obviously this does not provide a solution at all. In the finical crisis, the problem is clearly that the junk the banks were selling should have never been on the market in the first place.

The financial regulation side of the argument says that, "There should be a law against selling the finical equivalent of crack cocaine". Banks should not be allowed to sell highly risky loans and sell these loans to other middle men discussed in mortgage backed securities while holding only 3% reserves. These practices have bitten the world economy twice now. As George Bush would say, "trick me once sham on you, trick me twice well shame on you again , but trick me thrice and well we all are SOL".

Or something like that...