Mark Thoma, of the blog Economist’s View made my day today with a post that vindicated some of my critiques of Marginal Revolution‘s Cowen’s Op/Ed about reforming the banking system. Cowen’s piece can be found here.

The first point that Thoma finds problematic with Cowen is his confidence in a self-regulating system.


I am not as confident as Tyler is that his scheme will work — I am more inclined to pursue the regulatory route — but in any case the problem of how to enhance the stability of the financial system is not about the size of banks as much as it’s about interconnectedness and the degree to which financial firms can take risks without facing the full consequences of their decisions.


I should also point out that Thoma is wise in his critique of the principle “the greater the size, the gtreater the evil.” Thoma notes that there were many bank busts and runs through American history, among them the many small banks that went under during the Great Depression.

The greatest point of agreement between Thoma and I is in the neccesity of oversight.

Money quote:

It seems to me that given the lack of transparency in the financial system — the inability of investors to monitor the risks that banks are taking with the money they invest, and the lack of solutions such as reliable ratings agencies that help to overcome this informational disadvantage — making investors liable for even more than they actually invest in a bank would kill the incentive for average or even above average investors to put money into this industry (and the ability of shareholders to monitor corporations even when informational problems are much less severe appears to be problematic).

Thoma effectively shows the flaw in Cowen’s logic, better than even I could say it.