How Inequitable Rules Stoke Financial Crises and What the Banking Agencies Should do to Cut This Link

Last week, OMB issued another edict redesigning the way most of the federal government writes rules, going beyond its earlier directive to consider competitive impact now also to demand detailed consideration of the broader public good, especially when it comes to economic equality.  I focused on public-good regulation in last week’s memo because it is sadly alien to federal financial regulation even though, as OMB says, “the benefits and costs of a regulation are ultimately experienced by people.”  I grant that economists are people, but some are also people who don’t like people, at least when qualitative assessment of what people need challenges the quantitative conclusions they cherish.  Pending banking rules thus ignore the public good in favor of complex market constructs, rationalizing them on assertions that, whatever else befalls finance, crises are less likely.  This is a methodology fraught with perverse consequences, the most important of which is that the agencies’ standards will hike the risk of financial crises precisely because they omit distributional analysis.