Our political/financial system is steeped in fraud made possible by a government fueled by pay for play. "Bezel" some have called it. And until that aspect is addressed. The GS JPM Gordon Gekko pigs will continue to control all– and destroy us all, themselves included, in the process.

Regarding Kurgman's view of TBTF, Who Cares, I find it perfectly understandable while wearing bifocals, but bafflingly obtuse when I take of the econo-specs and look at the real world. Yes, systemically things are sufficiently complex that we can never be sure which institutions would, by their collapse, pose a systemic threat. This is in essence the same point Yves makes here with, I may say, rather greater clarity.

"Who knew?" will always be the question it may be better not to ask. Most who read here will recall the argument of March 08 that a failure of Bear might lead to a failure of JPM, and a failure of JPM might lead to an uncontrollable cascae of credit default swaps; hence Bear had to be backstopped. Let's assume that this is true then, that we can never be sure whose failure will be devastating and hence no large failure should be allowed. . . . Or rather, no _uncontrolled collapses_ should be permitted. Yes, seize AIG, fire management, and dictate a settlement. Please. (I mean it hasn't happened YET, so this is still an unmet condition.)

But the argument Krugman seems to be waxing smooth here is a false opposition, which he has to know: Either prevent institutions growing too large or do controlled demolition when failures occur. What is to prevent doing BOTH? Nothing, except a lack of political will. The argument against 'Too Large' is not principally about systemic risks of failure; that is a misunderstanding. It is about systemic distortions PRIOR to failure. It is about Too Big To Regulate. It is about market dependence upon a handful of players who exploit their position in ways to the loss of everyone else and all of society. It is about perverse market behavior because the incentives of a few mammoth firms do not align either with their counterparties, their markets, or their country of origin (or any country). It is about, to put it simply, preventing cancerous malignancies. Yes, behemoth financial big boys create massive systemic risks, and should be wound down in a controlled rather than a catastrophic fashion. But they pose those risks only after fouling the markets and the countries in which they operate: they warp the financial system to their own benighted purposes. Even when they may not intend to, a separate point.

There is not regulatory arrangement which will prevent a) chicanery (to be kind), or b) institutional bankruptcies. Cleaning up the eruction of institutions will be far more feasible where those institutions have a mandatory maximum size: This is a return of the trust-busting, and must become a primary political issue of the next ten-twenty years. The Financial Big Boys are the equivalent of the late nineteenth century trusts, the Dystrusts. They have completely captured the government, but failed in their own industries, producing massive short-term profits for themselves at the expense of any real growth for their societies, and most of their profits are generated through leverage and speculation rather than through actual production or investment, of which they produce very little.

Bust the trusts. Paul, can you get your head around _that_?

I do see some evidence of sensible policy in making dark pools more transparent and fiduciary responsibility for brokers, but doubt whether the tangled chains of consequences have been followed through. Paul kedrosky over on growthology argues that the requirement for funds to register with the SEC will cause problems for venture capitalism for instance. Interestly clusterstock is reporting a rather frosty reception of the regulatory changes by Sheila Bair at the FDIC, so it seems a few feathers have been ruffled.

Consider some retro positions. Up until early this year, I considered the FED to be responsible for the Great Depression by keeping (then nominal) interest rates too high. In view of that policy one must take a critical view of today's activities:
1- Which of the eight presidents that faced a depression actually solved it without stagflation or depression (Harding, Hoover, FDR, Johnson, Carter, Reagan, Clinton, Bush). Answer Harding. Why, he cut BOTH government spending AND taxes. Each of his successors did one but not the other.
2- The progressive era has left us with a system of government where someone else (the rich, the corporations) pay your taxes. Why are they so willing to pay up? Answer, because they transfer their risks to the government in the form of regulation, retirement, social security, etc.
3- What happens when the money interest (the rich and corporations) won't or can't pay their expected level of taxes (according to Misha's economic analysis, income tax revenues could be down by as much as 40% this year alone)? Answer: more borrowing. Toss up question, what happens when the government needs to borrow more? Answer: investment is crowded out of the economy, pensions, stock market collapse as companies earn less and less.
4- The progressive economy was built on the new Science of macro economics. Is macro economics a science? Answer: After the equation of GDP = MV (money times velocity) = PQ (price times quantity), there is no macro. The use of mathematical derivatives to derive scenarios for 'managing' an economy by the fed or the government is NOT possible, as there is always arbitrage which takes away any advantage to the regulator. Money velocity peaked (again according to Misha's analysis) in 1997 at 2.2. This was Greenspan's finest hour as he prevented a World economic collapse at that time. Banking deregulation actually allowed the system to teeter along for another ten years or so, but the arbitrageurs finally had their way in 2006 and here we are today facing a depression. This is the second depression in the progressive era, there was one in America during the classical era from 1871 to 1894 as America dealt with the post Civil War government debt and subequent deflation.
5- What can be done? Follow the Harding plan, eliminate the progressive tax system, except for Government mandates such as defense spending. All other taxes should be paid by the user either as fees or as excise taxes. Cut government spending to match revenue. Let the insovlent banks fail and close them. Eliminate the Fed and introduce a Free Banking System. Require the banks to buy deposit insurance to protect depositors to a minimum amount. Require bank depositors to buy additional insurance to cover their deposits above the minimum ceiling. The insurance must be payable on demand. Will this be done? No, so welcome to a depression. It won't feel like one, but I do anticipate an unemployment rate in the mid teens by 2015, causing all of us a great deal of pain.
6- Money velocity is currently well above 1.7. During the depression it fell to around 1.1 as the population held on to cash, before a recovery took place. This implies the economy will shrink by another 30-40% before things begin to improve. welcome to your future.

Your point about the shortcomings of the Obama administrations regulatory reform proposals being features and not bugs is well taken. I missed the linkages between Obama spending his political capital pushing back on the financial industry with serious reforms.

Shelby has always been a great vigilante during this crisis and folks should pay more attention to the sensible old crow.

Alfords point about the Fed not having the political will to incur short term costs to achieve financial stability yet having the political will to incur short term costs to curb inflation is an outstanding observation.

The need to look at reform from a products based perspective is key as well. Dallas Fed Jeffrey Lacker addresses re-implementing a maximum loan-to-value regulatory framework and limiting banks exposure to commercial real estate CRE loans on
their balance sheets. Lacker points out that teh 50 banks that have failed since 2007 had construction loans in excess of capital near 280% on average.

Fisher's piece can be read at ZeroHedge http://zerohedge.blogspot.com/2009/06/dallas-fed-on-curbing-irresponsible.html

Also, at ZeroHedge today is a proposal written by me that calls for a regulatory overhaul of the financial system that entails doing away with the TBTF doctrine altogether http://zerohedge.blogspot.com/2009/06/guest-post-proposed-grayson-glass.html

There are two competing political traditons at work in our culture. One is that of Aristotle. It holds that the rank and file are capable of self-rule and places sovereignty in the hands of the people. Free speech is its truth-finding process, perhaps in no place more eloquently expressed than in the Virginia Staute of Religious Freedom, written by Thomas Jefferson:

[T]hat truth is great and will prevail if left to herself, that she is the proper and sufficient antagonist to error, and has nothing to fear from the conflict, unless by human interpositon disarmed of her natural weapons, free argument and debate, errors ceasing to be dangerous when it is permitted freely to contradict them.
~

The other is a more elitist political tradition that comes down to us from Plato and the stoics. As Reinhold Niebuhr points out in The Nature and Destiny of Man, its "philosophers were optimistic in their confidence that the wise man would be virtuous; but, alas, they had no confidence that many could be wise." Perhaps Seneca summed up the sentiment best when he prays "forgive the world; they are all fools."

Since Plato had no confidence in the common man's ability to self-rule, he called for a class of "philosopher kings" to preside over the hoi polloi. Niebuhr speculates that Plato's "philosopher kings" have evolved into today's "scientist kings," Geithner, Summers, Bernanke and Greenspan being modern-day examples.

Plato did not believe in the merits of free speech nor of the general public's ability to discern truth from untruth. Hannah Arendt elaborates further:

The chief difference between Plato and Aristotle in their political philosophies is that Plato, writing consciously in opposition to the political life of the decaying Greek city-state, no longer believed in the validity of the kind of speech that accompanied–in the sense of being the other side of–political action. To him, such speech was mere opinion, and as such opposed to the perception of truth, unfit either to adhere to or express truth… Persuasion had become to him a form, not of freedom, but of arbitrary compulsion through words, and in his political philosophy he proposed to substitute for this arbitrary compulsion the coercion of truth. Insofar as this truth was essentially speechless and could be perceived only in the solitude of contemplation, Platonic man was already not a "speaking" but a rational animal, that is, a being whose chief concern and enlightenment lay in himself, in his own reason, and not in the faculty of speech, which by definition presupposed his living among and managing his life together with his equals. When Aristotle connected speech and freedom, he was on the firm ground of a then still existing tradition rooted in experience. Yet in the end Plato remained victorious because of the fact that the Greek city-state was decaying beyond remedy–something that Plato who, as a full-fledged Athenian citizen, unlike Aristotle, knew and whose influence he suffered severely–and whose ultimate ruin he feared and tried to prevent.

http://findarticles.com/p/articles/mi_m2267/is_2_69/ai_90439534/pg_14/?tag=content;col1

Ror:
I am one of the few people who goes further than worry about Fed "independence". I say the Republic survived from 1792-1913 without a Fed. Kill this beast.

The first structural reform HAS TO BE re-instating Glass-Steagal. 1) Separate commercial banking from everything else, because it's DIFFERENT and has the capacity to bring the entire system down overnight. 2) Recognize that the shadow banking sector (especially MMMF and CP) is banking and needs to be regulated as such. 3) Eliminate the bank SIV and Conduits whose only purpose is to avoid regulation and transparency. 4) Elminate bond insurance (e.g. MBIA) and CDS entirely. Interest rates are supposed to reflect risk premia and these insurance devices break that relationship. 5) Require ALL money managers, hedge funds, etc. to be registered regardless of size and regulate them from the standpoint of leverage and maturity mismatch.

–RueTheDay

That has been Congress' desire since Nixon's time. And pretty much the reason why the leader of the NY Fed was put in charge of the Treasury.

It's ingrained in the Federal government for two generations now. It'll take a radical act to undo the arrangement now.