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Lorenzo Bini Smaghi, a member of the ECB Executive Board, penned an op-ed in the FT today entitled "It is better to have explicit rules for bail-outs." Given the relative simplicity and directness of such a title, one would expect the piece to lay out the logic behind such a statement. Instead, what follows is largely nonsense,and self-contradictory blather.

Let's begin:

"One of the many lessons we can draw from the financial crisis... is that economic agents do not always behave rationally, especially when they take decisions affecting others. Research has shown in particular that agents are not only motivated by self-interest, as economists are keen to believe, but also by considerations of fairness."

A strong start - I'm with you so far, Lorenzo.

"Such attitudes make it difficult for governments to act consistently in times of crisis, especially when elections are close. This was notably the case in September 2008, shortly before the US presidential election, when Congress, despite the gravity of the situation, rejected the government's bail-out plan until Lehman Brothers' failure made it apparent that the risk of financial collapse would have devastating effects for all."

Mmmkay - not the best example. Congress rejected the government's bail-out plan not out of considerations of fairness, but because the Democrats tried to ram it down the throats of Republicans too blinded by ideology and obstructionist predispositions. Maybe our author is trying to be polite.

Regardless, he believes that democratic governments cannot be relied upon to react swiftly to address crises:

"Systems and institutions with specific crisis-resolution mandates thus need to be established to permit rapid responses."

Therefore: clearly established, fixed procedures for bailing out (woops, "resolving") an institution in crisis to prevent contagion is the way forward. Would this not create moral hazard? Would not this not allow the clever folks at large banks, investment firms, and hedge funds to find ways around the fixed rules, just as they have consistently done in the past? Would it not be better to provide regulatory bodies with resolution powers that are both broad and ambiguous enough to create uncertainty for financial actors as to when/how they might get bailed out in the future? Would this not go some distance to preventing them from gaming the system just as they have consistently done in the past?

Lorenzo's argument seems to be that elected officials should not be trusted to solve problems in the heat of the moment. There is some truth to this: it's messy and leaves you vulnerable to political cycles and populism. Ad hoc crises resolution efforts at the national level can also make things worse at the international level - we saw this with Ireland's unconditional guarantee of bank liabilities back when the crisis was as its worst.

But it does not follow that iron-clad rules need to be laid out in all cases. Fixed rules based on the last crisis are almost certainly not going to be well-suited for the next one - we do not want to train our generals to fight the last war. Smaghi does not seem to have grasped this fundamental lesson from history at all:

"Moral hazard should ... be addressed by establishing institutions and procedures that allow for incentive-compatible solutions (carrots as well as sticks). This means, in particular, that financial assistance, if needed to avert a major systemic crisis, can be granted on strict conditions that aim to prevent any recurrence of the problem."

Really? Any recurrence of the problem? Please don't insult your readers with this drivel. Finally:

"[M]oral hazard cannot be tackled simply by assuming that crises will not occur. Nor can it be assumed that letting an institution or a country fail is always and everywhere the most desirable solution, as the post-Lehman experience has shown. Decision-makers in both the public and private sectors must thus be ready to deal with worst-case scenarios and make sure that they are not prevented from delivering the appropriate decisions."

Aside from stating the blindingly obvious, I read this last paragraph undermining Smaghi's argument entirely. Given the fact that the next crisis will not be identical to the previous one, flexibility is key. "Explicit rules for bailouts" is not flexibility, and is certainly not going to equip decision-makers with the capacity to deal with worst-case scenarios. Indeed, explicit rules may very well prevent them from delivering appropriate decisions.

*deep breath*

Flexibility essentially means power. The debate that we should be having is over how much power financial regulators should have/are able to use effectively. How much should we be able to rely on this power? Will it dampen the inherent moral hazard of future government bailouts?

Smaghi's argument is not so much an argument but rather a vague collection of statements that are tenously linked together, not particularly convincing, and seemingly self-contradictory. He has contributed nothing but confusion.

I'm about a third of the way through Charles Kindleberger's Manias, Panics, and Crashes - a historical examination of financial crises over the past few centuries. It's an interesting read, and Kindleberger regularly sprinkles in some real gems. For instance, in discussing some of the causes of over-zealous investment during a financial bubble, he opines that "There is nothing so disturbing to one's well-being and judgment as to see a friend get rich." The same can be said of our financial institutions.

Here's another: "For historians, each event is unique. Economics, however, maintains that forces in society and nature behave in repetitive ways. History is particular; economics is general."

Kindleberger tries to weave his way through the particulars to arrive at some general conclusions about crises, and it's sobering stuff. We're used to hearing about the Great Depression, but things pretty much drop off for anything prior. But let me tell you, there were crises galore in the 18th and 19th centuries. The worst part? Although the particulars differ, they tend to bear remarkable similarities to our latest meltdown.

In fact, many of the debates back then echo to the debates being waged today. Writing in the post-WWII period, Chicago economist Henry Simon was arguing that it was not the money supply, not government policy, but rather the instability of credit markets that created a fragile financial system: "He was concerned about the speculative temper of the community and the ease with which short-term nonbank borrowing and lending made society vulnerable to changes in business confidence." Again, the details have changed, but the collapse in confidence in uninsured non-bank lending was a major component of the credit crunch that fed our latest meltdown.

It's something to ponder as practitioners, regulators and policymakers pick up their socks and attempt to try again. How long before the lessons from mortgage-backed securities fade away and the unintended consequences of the latest policy decisions set the stage for the next crisis?

The Links
- For the second year running, the World Economic Forum has ranked the Canadian financial system as the soundest in the world. (It's a decidedly lower bar these days, no?)

- Paul Krugman tries to explain why this is the case in his weekend editorial, but in his effort to create a narrative he misses some important points.

- For a more comprehensive look at the issue, Chrystia Freeland does the job well.

Missing from all of these summaries, however, is one minor niggling point: had the US not bailed out some of its major financial institutions, the story in Canada could very well have been very different.

A few thoughts
The lesson of Canada is not one easily grafted on to major banking sectors like those in the US and UK. Underlying all of this prudent banking is a fundamental lack of competition, both domestic and foreign - something that simply would not fly in any city aspiring to be a global financial hub. To a certain extent, the ease with which Canadian financial institutions have access to American markets has given them space to take a more conservative approach. And while the lack of competition may be stable, it's not something the customers of Canadian banks are always the beneficiaries of, either.

I recently read a US Congressional research report attempting to draw lessons from the Canadians for American banking reform efforts. One of the most noticeable contrasts is between Figure 1 and Figure 2 in the report. Compared to the relatively simple and centralized regulatory structure in Canada, the flow chart of the US system is reminiscent of that ridiculous COIN graph. Nevertheless, the report concludes that, essentially, the Canadian system works pretty well in Canada but is heavily context-specific. There are good lessons to be learned, but they are not easily transferable elsewhere. Sorry.

The fate of Ben Bernanke's confirmation is getting a lot of play in the US media today. Momentum for his reappointment has slowed considerably over the past few weeks, and he is losing Democratic votes by the day. The Democratic leadership is reportedly 'scrambling' to shore up Bernanke's support, but it's possible that Ben's candidacy is dead in the water. That is remarkable to me.

President Obama's new banking proposals have opened another front in the Bernanke battle, and many, like Simon Johnson, are appropriately calling on Ben to clarify his position on these reforms. There is a growing lack of confidence in Bernanke's conviction to take the fight to the banks, and without picking up that mantle in a public and convincing manner, Bernanke might be done at the Fed.

Stay tuned, this is snowballing fast.

As Dave covered yesterday, Paul Volcker finally emerged from his (large) broom closet in the White House as the major force behind Obama's new banking sector reforms. To recap, the US president proposed two new reforms to end 'too big to fail' and limit the proprietary trading operations of banks. His proposals will: 1) prohibit banks from owning, sponsoring or investing hedge funds, private equity funds or proprietary trading operations for their own profit, unrelated to servicing their customers- the so-called 'Volcker Rule;' and 2) prevent the further consolidation of the financial industry.

On the surface these reforms mark a dramatic departure from the administration's standing approach to financial sector reform (fairly benign). But before we get ahead of ourselves with excitement, it is important to recognize the considerable obstacles to these proposals ever becoming law, and examine whether what sounds good in theory is actually inadequate in practice. A few thoughts:

-Obviously we are a bit light on the very critical details. For instance, how exactly will the administration prevent further consolidation in the industry, or end 'too big to fail' as we know it? By limiting the size of individual firms through a cap on assets under management or deposits? Or by applying robust anti-trust scrutiny to any future mergers and acquisitions of financial firms? It seems the administration has collapsed two very different and tricky issues into one concept: limiting systemic risk. You can cap a bank's size, and therefore risk to the system, through higher capital adequacy requirements, but this doesn't address the off-balance sheet activities that were the real systemic threat during the crisis. You might reply that the Volcker Rule would largely resolve the off-balance sheet problem, but it seems the administration has very consciously linked the prohibition on these activities to the prevailing bank-holding company model. Remember, all the big investment banks converted into bank-holding companies during the crisis to access Fed funding, which then entailed setting up retail banking, or deposit-taking, operations. Under the Volcker Rule, these banks would now be unable to de-link retail and trading operations, even conceptually, thus prohibiting every major bank from engaging in proprietary trading unrelated to traditional brokerage (think boring mutual funds instead of exotic securities). There goes almost ALL the profit-making activities the banks currently have.

But what if banks like Goldman Sachs and Morgan Stanley simply converted into a different legal entity once they no longer relied on easy Fed funding for their trading operations? By ditching the small retail operations they have built, they could theoretically return to the old model once they are self-sustainable, thereby bypassing the Volcker Rule all together. This would put banks with huge depository operations like JPMorgan Chase and Bank of America at a competitive disadvantage. Everyone joked before the crisis that Goldman Sachs was the biggest hedge fund in the world: what prevents them from becoming something like an alternative asset management firm? It's customers would in theory possess a higher risk-tolerance and proprietary trading operations could be justified on serving this investor profile. Without formally resurrecting Glass-Steagall, which doesn't appear to be on the table, I am unclear how the administration can put in place a regulatory apparatus that stays two-steps ahead of financial and legal innovation.

-These reforms are an important step in the right direction, but they are also blatantly political, which makes them vulnerable on a number of levels. The administration is claiming that the proposals have been under serious discussion for months, they just needed to be refined and introduced at the appropriate time. This is plausible, as they were proposed on the very day that health care reform 'died.' The administration may have simply been planning a big financial reform push following health care's conclusion, which they expected this month. And surely the posture of bank execs before Congress last week, not to mention record bonus announcements, didn't do themselves or their industry any favors. 'Keep it cool' Obama seems genuinely furious.

But its timing on the heels of the Massachusetts primary in which a Republican candidate won the seat held by Ted Kennedy for four decades smacks of calculated populism. The FT said as much in its editorial. This leaves it subject to political horse-trading, both within Congress and between legislators and the administration. Could it become a bargaining chip in preserving the controversial consumer financial protection agency, Obama's centerpiece reform? Obama could pick off a few Republican supporters for the banking proposals; John McCain has expressed some similar sentiments recently, and the issue taps right into the anti-Wall Street fervor that shows no signs of abating. But he could also lose votes on his side, like Joe Lieberman or the chairman-in-waiting of the Senate Banking Committee Tim Johnson, who is a 'friend' of the financial services industry, to put it diplomatically. If financial reform gets held up until after the mid-terms (when Chris Dodd, current chairman of the Senate Banking Committee, retires) a Johnson chairmanship could pose real problems for the administration.

-Finally, let's say that the reforms get enacted in some form or another. The big winners are then the hedge fund and private equity industries. A lot of people predicted that they would increasingly fill the risk-taking space vacated by the big banks. But with Goldman trading the daylights out of essentially free loans from the Fed, the current status-quo retains plenty of risk-taking in the big institutions. But if prop desks are truly scaled down at these firms, suddenly hedge funds become the major traders in a range of instruments and markets, providing a goldmine to the industry. This raises a whole host of unresolved problems, including systemic risk considerations (remember Long Term Capital Management?). Reform of the hedge fund industry has proven surprisingly difficult in Europe, and limited reforms have thus far been proposed in the US.

So in conclusion, I am left with two basic questions: will the reforms be precise enough to achieve their objectives in an innovative marketplace, and what are the most effective tools in limiting the systemic risk posed by individual firms? I'm eager to see the details of the proposals.

Well blow me down. I don't think one needs three dozen interviews to figure that one out: it's pretty obvious that the various US financial regulatory bodies didn't see this coming, nor did those in the other major financial centres. However, as Arnold Kling points out, neither did most of the suits at the very banks within which the risks were being taken. I think it's fair to say that it has been a learning experience all around.

But exactly what kind of lessons are we learning from this crisis? It's very important that we learn the right ones. Even if we acknowledge that there was a collective cognitive failure on the part of our regulators, there are a couple of different ways to run with this.

If we're of the mindset that we should see bankers hanging from Blackfriars bridge, or have their heads on pikes or whatever, I don't think the discussion will go very far. Despite the obvious excesses of financial sector, I am still waiting for evidence that performance bonuses to Goldman Sachs employees has been the cause of our financial crisis.

But let's agree that the Fed F'd up. What should we do about this? One option is to use this argument to argue against the re-appointment of Ben Bernanke as Chairman because of his obvious failures to mitigate the crisis. While there is merit in digging up all the mistaken decisions by the Fed in the past decade, scapegoating will not address the problems of tomorrow. John Maynard Keynes is reported to have said: "When the facts change, I change my mind. What do you do, sir?" When the facts changed for Bernanke in late 2008, he also changed his mind. Although late to the party, the Fed's willingness to adapt to the crisis over the last 16 months has been a crucial part of slowing the economy's decline and stimulating what is, to date, modest signs of recovery. (I think Rory agrees) (wait, so does TIME)

But even if we accept that the Fed has learned from some of its past mistakes, this has not addressed the fundamental problem with financial regulation: the regulators don't have the capacity to know everything that's going on. They never will. The people who work at investment banks, hedge funds and the like are too smart and too motivated. There will always be loopholes, and those loopholes will be found. That said, it should still be possible to avoid the kind of crisis that we just experienced, with huge sums of money (your money, my money) being used to prop up the balance sheets of our financial giants. I see at least three possible avenues for the future:

First, concentrate the US regulatory system into fewer bodies. I couldn't find the organizational chart I wanted, but you can get a sense of it from this summary. Compared to many other industrialized countries, this is madness. Having one financial entity regulated by so many different government bodies will leave gaps in coverage. It's hard enough for one government entity to share information with itself - multiplying entities will multiply the problem.

But with a more concentrated financial regulator, the information-gathering problem will not disappear. This is why I find Paul Volcker's vision for the US banking sector to be persuasive. Since we cannot prevent financial innovations and we cannot expect our regulators to understand all the risks associated with them, we should at least prevent our "systemically important" financial institutions from playing with them. The risks and rewards should be realized by firms which are able to fail.

Third, let's beef up the regulatory standards for our core financial industries - the ones we can't afford to see fail. The Basel Committee on Banking Supervision recently released its list of five suggestions for doing just that. This is an excellent place to start the discussion, and efforts to coordination internationally will help address concerns about competitiveness.

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I think that it's crucially important to learn the right lessons from this financial crisis and avoid being side-tracked by the promise of a quick fix (think: banking bonus supertaxes or the Tobin tax). From where I'm sitting, one of those key lessons will focus on cognitive limitations - the limited ability of our government officials, regulators, banking execs and individual investors to understand complex realities of the markets they interact with. Once we accept this, we can begin to build buffers against the problems that will inevitably arise.

Now if you'll excuse me, in recognition of my own cognitive limitations, I have a stack of holiday reading to attend to.

That was Paul Volcker's message to the Future of Finance Initiative, delivered earlier this week. Responding to what he viewed as timid proposals from the private sector on how to go about their business, Volcker proceeded to lay out what he saw as the key priorities. I can't find a useful way to cut this down, so I will quote it as a whole:

Let me just suggest, if I may, the way that I would go about this. I am not alone in this, and in fact I think that I am probably going to win in the end.

First, let us agree that we have a problem with moral hazard. I do not think that there is any perfect answer in dealing with it, but I would suggest that we can approach an answer by recognizing that elements of finance have always been risky and that's certainly true of the commercial-banking system.

I think we need the commercial banking system for more than automatic teller machines. Commercial banks are still at the heart of the system. In a crisis, everybody runs back to the commercial banks. They, after all, run the payment system. We cannot have this global economy without commercial banks operating an efficient payment system globally as well as nationally. They provide a depository outlet for individuals and businesses, and they are still big credit providers for small and medium-size businesses, but they backstop most of the big borrowers as well. The commercial-paper market is totally dependent on the commercial banking market. They are an essential financial institution that has historically been protected. It has been protected on one side and regulated on the other side.

I think that fundamental is going to remain. People are going to think it is important, it is important, it needs regulation and in extremis it needs protection—deposit insurance, lender of last resort and so forth. I think that it is extraneous to that function that they do hedge funds, equity funds and that they trade in commodities and securities, and a lot of other stuff, which is secondary in terms of direct responsibilities for lenders, borrowers, depositors and all the rest.

There is nothing wrong with any of those activities, but let you nonbank people do it and you can provide fluidity in markets and flexibility. If you fail, you're going to fail, and I am not going to help you, and your stockholders are going to be gone, and your creditors will be at risk, and that is the way that it should be.

How can I be so blithe about making that statement? We need a new institutional arrangement which I believe has a lot of support. We need a resolution facility. What can that resolution facility do? If one of you fails and has systemic risk, then it steps in, takes you over and either liquidates or merges you, but it does not save you. That ought to be a kind of iron cross.

In other words: Old Man Volcker is back and he's handing out detentions to the unruly schoolchildren. This is the kind of ballsy speech that only someone with Volcker's authority and experience could pull off.

I find this vision very compelling. There is no obvious reason why "too big to fail" financial institutions should have the competitive advantage of government guarantees while at the same time being free to dive head-first into the riskiest types of financial tools that may or may not be beneficial to the economy. We've just seen what the downside looks like, and it is ugly.

As Simon Johnson explains, this could well be Volcker's moment. It's true that his vision is glossing over the challenging details that would need to be worked out, but so be it. If Volcker can shift the public consensus in his direction, he will have accomplished a great deal.

Rory's post on the corruption perceptions index below has prompted me to follow up with another global country ranking: the financial secrecy index.

Jut a quick thought I have been tossing around in my head for the past few minutes...where the heck is Paul Volcker?

A giant of policy making, Volcker was brought into the Obama administration in an advisory role, but one that was thought to be an integral part of the US president's financial and economic policy formulation.

Almost ten months later, and he is seemingly MIA, minus the occasional statements that lead you to believe he thinks his boss is doing far too little in addressing the financial system's problems.

Which might just be the explanation for his absence.

-Stiglitz thinks the banking system is even more broken today than on the day Lehman died.

-A very good measure of business sentiment is how quickly business leaders are dumping their shares...well, they are really dumping. Bad sign??

-Martin Wolf's lessons to be learnt from Lehman's demise and its aftermath.

-A lot of political hot air has been expended over executive pay in the post-Lehman age, because its easier to grandstand over the compensation of a few top executives, than it is to actually reform the perverse incentives and regulatory failures that led taxpayers to commit such capital to the survival of the financial system.

One source of that hot air, Super Sarko, looks ready to sink a summit over a NON-ISSUE!! Reforming compensation practices is important, but please, there are far greater matters to address in Pittsburgh.

Last week, as Rory pointed out, the idea of a Tobin tax once again appeared in popular economic discussion. This was prompted in large part because Lord Turner, the head of Britain's Financial Services Authority, re-introduced the idea of the Tobin tax as a possible way to keep the City from growing too big - and yes, 4-5% of GDP is probably too big.

So what is this Tobin tax, and does it have merit? This post will take a stab at answering these questions.

What is it?
As the name might suggest, the idea was introduced by Yale economist and Nobel laureate James Tobin in 1972.The Tobin tax consists of a modest ad valorem tax applied to certain financial transactions; proposals for taxation levels range from 0.5% to 0.01%.

The appeal of the tax is two-fold. Firstly, the flat tax would specifically target short-term capital flows. For example, if the yearly cost of a “round-trip” investment is 0.2% (a 0.1% tax, applied twice), then the monthly rate would be 2.4%; the weekly rate, 10%; and the daily rate, 48%. In other words, in order for a round-trip investment of one day to be worthwhile, the return would need to be nearly half-again as big as the initial investment. Over the span of a year, however, the tax rate is considerably less.

Why target short-term capital flows? Although opinions on this vary, one line of thinking is that the flows of short-term capital (hot money) are less productive than longer-term foreign investment. Investors are prone to herd behaviour and often lack full information. Larry Summers called them "IDIOTS" but the technical term is noise traders. Either way, the ability to move money around quickly and at low cost can produce volatility. Volatility is bad when you're trying to use foreign investments to build an economy. If that money just picks up and leaves, you're in trouble.

Indeed, it was precisely this problem which helped cause the Asian financial crisis in 1997-8: the collapse of Thailand's economy made investors panicky about the whole region and they pulled their short-run investments out en masse. At least, they pulled their money out of countries that didn't have capital controls: China, which had controls, was largely unscathed.

Insert the Tobin tax. By placing a fixed cost on the movement of money across borders, you force investors to think harder about their investments - hopefully making them more productive. The tax also provides stability by acting as a buffer against the herd behaviour of international capital markets. Moreover, the tax acts as a significant source of government revenue (which could be good or bad) and, as explained above, wouldn't scare away longer-term foreign direct investment. Great idea, right?

Will it work?
The answer depends upon what your objective is. The fact is, a flat tax on international capital movements is a pretty blunt instrument indeed. Even a 0.1% tax can be a huge cost, and could result in significant market distortions.

For instance, it's possible that a Tobin tax could punish countries that don't use major world currencies. If you want to convert Chilean pesos into Indian rupees to invest in India, you will most likely have to switch the pesos to dollars, then the dollars to rupees. With a Tobin tax in place, it's possible that this transaction will be taxed twice. Bad news for developing countries.

A similar story unfolds with international trade, where firms often hedge their contracts through spot or swap transactions. If these secondary transactions were taxed, international trade - one of the fundamental benefits of market capitalism - could be less appealing.

We could also spend a great deal of time discussing the practical difficulties of implementing such a tax. International coordination at the G20 level would be a minimum for this to be truly effective at slowing hot money and reducing volatility.

If your main concern is to generate revenue, the Tobin tax might still be a good idea. I've seen proposals for using the tax as a way to generate aid money for developing countries. Lovely notion, but Tobin himself explicitly rejected the idea of using the tax primarily as a revenue-generator because the point was to create financial stability.

But if the point is to create financial stability by limiting the size of the financial sector, as Lord Turner suggests, Willem Buiter argues that the Tobin tax is still a lousy idea. A transaction tax would not even begin address the fundamental problems in our financial markets, especially the problem of moral hazard (read his article for more detail, if you're interested).

The appeal of the Tobin tax is understandable: its beauty lies in its simplicity. But it is too blunt a tool to achieve what is being asked of it, and the G20 is rightly focusing on other issues. Nevertheless, this will not be the last we hear of the Tobin tax.

A few weeks back I looked at the prospects for meaningful financial sector reform in the US, and ended on a decidedly pessimistic note. To recap, health care and climate change will soak the congressional agenda and shrink Obama's political capital, leaving an overhaul of the nation's financial regulatory structure for a less accommodating political environment in 2010.

The Politico agrees, in a wonky kinda way, with this interesting look at the impact of Ted Kennedy's death on the prospects for financial sector reform. Senator Chris Dodd, current chair of the Senate Banking, Housing and Urban Development Committee (financial sector reform), is next in line for the chair of the Senate Health, Education, Labor and Pensions Committee (health care reform). Following Kennedy's death, and in need of high-profile achievements in the midst of an uphill reelection bid, Dodd might jump ship from financial to health reform.

If Dodd does switch chairs, what would be the implications for the reform effort? Most importantly, the financial services industry would gain a major ally in Senator Tim Johnson, the next Dem in line for the Banking chair. By one account he has been a vigorous opponent of capping credit card fees/rates, proponent of 'voluntary' industry standards, and anti-mortgage renegotiation. The financial industry is also a major financial backer of the Senator.

Dodd has also been a big proponent of the proposed consumer protection agency, something Johnson, as a friend of credit card and mortgage lenders, would likely attempt to kill or diminish beyond recognition.

Dodd is often accused of being too close to the financial services industry, which he undoubtedly is, but to his credit he has been a driving force behind the president's reform proposals and instrumental in reforming the credit card industry. Switching committees would be a blow to the reform agenda.

Stay tuned...

In a FT op-ed, Stephen Roach presents 'The case against Bernanke.' Roach calls the reappointment 'short-sighted'; I think his criticism is too fixed on the now distant past.

He argues that despite Bernanke's aggressive and creative response to the crisis, his weaknesses and ideological orthodoxy helped create this mess:

It is as if a doctor guilty of malpractice is being given credit for inventing a miracle cure.

He goes on to say that the jury is still out on whether the Fed's crisis response will work in restoring growth and stability. This is a sensible argument, but surely Bernanke deserves the chance to finish the job. A more appropraite criticism would be that Bernanke's 'philosophical conviction' is ill-suited to influence and implement financial sector reform. But even on this point Roach's argument falls short, as Bernanke has demonstrated an incredible intellectual flexibilty and ability to depart from the pre-crisis orthodoxy.

A second-term should not be seen as rewarding the failures of pre-crisis Bernanke. Instead, it should be welcomed as a vote of confidence in a man transformed by the crisis and using every measure in his monetary toolbox (and making some new tools up along the way) to end it.

US President Obama will reportedly nominate Fed chief Bernanke to a second term this week, ending intense speculation over the reappointment.

Bernanke still has to gain the approval of a not-so-friendly Congress, but after the obligatory grandstanding that will undoubtedly come.

This is the right choice in my opinion; I've often expressed here my admiration for the Fed's response to the crisis. But Bernanke's second term will be anything but a victory lap following his central role in preventing another depression. The challenges he will face in unwinding the Fed's extraordinary response to the crisis, exercising some measure of systemic oversight, and defending monetary policy autonomy may be no less difficult than the challenges his first term brought.

The FT ran a front-page story this morning on the feds' role in the resignation of former Citi CFO Ned Kelly in July. I am a bit surprised that it is a revelation that US regulators are intimately involved in Citi's management and strategy.

Nowhere does the paper imply that this was inappropriate or overbearing. But the story speaks to a larger sentiment within the financial services industry against reregulation and government intervention in the day-to-day strategy and management of TARP recipients. This is a curious sentiment indeed, and demonstrates the short-term memory of some of the biggest recipients of taxpayer dollars.

As the firms largest shareholder and financial backstop, why wouldn't US regulators exert authority over the woefully mismanaged firm? We crossed the threshold of moral hazard/government intervention long ago; moves like this should be applauded as an important step towards restoring credibility and competence to Citi and maximizing the return to US taxpayers.

I subscribe to Kenneth Rogoff's view that wholesale reregulation is needed, and it is increasingly clear that the Obama administration has missed the boat on financial sector reform. The financial crisis has largely subsided, some of the largest bailout recipients have payed back the taxpayer, and profitability has generally returned to the sector. The industry is more self-confident and increasingly hostile to government intervention.

Further, the congressional agenda is now overwhelmed by the debate over health care reform, to be followed by energy/climate change reforms ahead of the Copenhagen summit. This ambitious and controversial agenda leaves little room for substantive financial sector reform in 2009. Small measures on derivatives are likely because those are the easy ones. Giving the Fed systemic powers? Much, much harder, and it is unlikely the Obama administration will have the political time or capital to push through reforms of this magnitude. If it bungles health care, which at this moment seems likely, the Obama presidency will shrink, the democratic party will fracture, and the administration's financial sector reform agenda will be downsized.

Reformers from South Korea to Slovakia have understood that you should 'never waste a good crisis.' Unfortunately, the Obama adminstration might have done just that.

No, not my own. The Newshour with Jim Lehrer, the nightly news program on America's public broadcasting station (PBS), has held an hour-long discussion with the Fed chairman entitled, 'Bernanke on the Record.' I highly recommend it (hopefully the link is available outside of the US, we have had the problem before of posting US-based content subject to distribution restrictions. Apologies in advance- scour YouTube).

The more Bernanke speaks in an open, frank forum (Americans might remember his much-lauded interview on '60 Minutes'), unencumbered by Fed-speak and congressional grandstanding, the more I am convinced that there is no better American to be steering the country's monetary policy/systemic reform/inflationary death spiral(?!?) than Bernanke. He's not only gotten the policies right (well mostly, minus one very very big exception), but has the unique ability to articulate the complexity of the crisis in a manner that enables lay audiencies to make sense of the madness around them. Imagine if a less imaginative or aggressive chief had been at the helm over the past two years. Where would we be?

- Bernie Madoff has been sentenced to jail until he is 221 years old.

- Willem Buiter shares his thoughts on the backroom rubber-hose-beatings that were carried out by the US and UK financial regulatory authorities to force the mega-mergers of Bank of America & Merrill Lynch and Lloyds TSB & HBOS, respectively, last autumn. Even to someone who barely understands these things (me), Buiter's suggestion of a rapid resolution mechanism for dealing with the insolvency of highly-leveraged banks seems like a really, really good idea.

- Incentives, incentives, incentives. They matter. Both when it comes to environmentally-friendly technology and also for health care (a good discussion on incentives the whole way through, but check out the bit on how Sweden dealt with hospital wait lines, at the end).