The ongoing financial crisis provides lessons that should be used to guide the redesign of our regulatory system. Recent proposals such as those of the Group of Thirty and the Congressional Oversight Panel do not appear to have recognized these lessons.
The government’s response to the weakening and failure of large financial institutions has been ad hoc and inconsistent. The Treasury and Federal Reserve decided to rescue Bear Stearns through a buyout by JPMorgan Chase; the negotiations were hurried and not well thought out. At the last moment, JPMorgan Chase had to raise its equity offer. Then, six months later, Lehman Brothers—an institution larger than Bear Stearns—was allowed to fail, raising uncertainty about both the true condition and the future treatment of other large investment and commercial banks. Within a few days, AIG was effectively nationalized and subsequently required unanticipated serial injections of capital.