yes, a real challenge

Mark Thoma:

…the Fed’s support of the financial market and financial institutions made it appear that it favored some markets and some firms over others, and that has been a problem. But I don’t think the Fed had a lot of choice.

It lacked the authority to dismantle large financial institutions outside the traditional banking system, it lacked the plans to do so even if it had the authority, and the fact that regulators allowed these institutions to become such a threat to the economy if they failed meant the Fed had to intervene.

That’s why, going forward, three things need to happen. Regulators need to reduce the threat these banks pose, they need to have plans ready if a threat develops anyway, and legislators need to give regulators the authority to take control of troubled institutions outside the traditional banking system.

But I have to admit that “the dysfunction of the political system” makes me wary of what will happen once the legislative process begins. Things could get worse rather than better, and reducing the independence of the Fed is but one of many ways that could happen. Even so, the need for reform of the financial sector is sufficiently strong to justify taking that chance.