The U.S. government has now explicitly said there are financial institutions (and other companies — autos, etc.) that are “too big to fail.” If that is (arguably) true, then they must be more highly regulated than the smaller institutions, particularly in terms of capital adequacy.
The reason is quite simple. If the government guarantees the debt of big companies, those institutions will have a much lower cost of capital than their smaller competitors, which is not only unfair but will destroy new and smaller companies, thus killing much of the job and productivity creating innovation in the U.S. economy. So far, the Washington governing class has failed to even discuss this disastrous consequence of the bailouts, let alone figure out a solution.
It is now widely understood that the current economic mess was a result of the Federal Reserve (Fed) keeping interest rates too low during the middle of this decade, as even Alan Greenspan now admits. Also, Congress pushed banks into providing mortgages to people who were insufficiently creditworthy, while at the same time resisting calls to provide more oversight and regulation of the two government‐sponsored mortgage giants (Fannie Mae and Freddie Mac).
In addition, the Securities and Exchange Commission chose to take its eye off the ball of rooting out financial fraud and instead imposed very costly, counterproductive and destructive rules on the financial industry, including forcing companies to “expense” stock options and incomprehensible “mark to market” accounting rules.
The economic situation will not appreciably improve without corrective action on the above‐mentioned items. In the late 1990s, the Fed implicitly followed the Taylor Rule, a formula developed in 1992 by John Taylor, a former member of the President’s Council of Economic Advisers and undersecretary of the U.S. Treasury, that indicated when to increase or decrease interest rates in conducting monetary policy. This resulted in relatively low inflation and strong growth.