Taunter has a comprehensive proposal about how to regulate financial services, dividing them into Boring and Exciting. Boring services are the following:
- retail deposits
- loans to retail customers, including mortgages
- retail insurance, including annuity products
- any custodial service beyond traditional settlement (i.e., if you hold something after T+3, you’re a custodian)
If you do any of those, then you are a Boring institution, you can do all Boring services, you face some significant regulations, and you get bailed out when necessary. If you do none of those, then you are an Exciting institution, you can do almost anything you want, and there is an ironclad rule preventing the government from bailing you out. Boring institutions cannot offer Exciting services (I think) and Exciting institutions cannot offer Boring services (that’s certain).
It feels like a modern version of Glass-Steagall (although I’m probably not doing it full justice) – create an explicit linkage between tight regulation and a government backstop, and protect the part of the financial system that affects ordinary people.
A key requirement of this system is that you have to be willing to accept the consequences of the collapse of an Exciting institution. I’m not sure that Taunter has sufficiently sealed off the real economy from Exciting firms, however. For example, suppose an Exciting firm offers revolving credit accounts to companies that they dip into to make payroll (to smooth out fluctuations in cash flow over the month). I don’t think this qualifies as Boring in Taunter’s scheme. But if the Exciting firm goes down, suddenly thousands of companies might be unable to make payroll.
I’m not saying this is a fundamental flaw; maybe the lines just need to be drawn differently. Or maybe I’m missing something. In any case, it’s an interesting way to think about the problem, especially for people who want to combine closer regulation of financial services that affect ordinary retail customers with free markets and financial innovation for sophisticated actors.
By James Kwak