After documenting extraordinary rent-seeking (and gaining) by financial institutions, John Quiggin comes to the following conclusion:
[A]ny serious attempt to stabilize the macroeconomy and return to sustainable improvements in living standards must involve a drastic reduction in the size and economic weight of the financial sector. Attempts at regulating derivatives markets have proved utterly futile in the face of massive incentives to take profitable risks, backed up by the guarantee of a government bailout.
The only remaining option is to separate these markets entirely from the socially useful parts of the financial system, then let them fail. Publicly guaranteed banks should be banned from engaging in all but the most basic financial transactions, such as issuing loans and bonds and accepting deposits. In particular, banks should be prohibited from doing any business with institutions engaged in speculative finance such as trade in derivatives. Such institutions should be required to raise all their funds directly from investors, on a “buyer beware” basis, and should never be bailed out, directly or indirectly, when they get into trouble.
The theme of separating out the utility-like, payment systems management functions of banks, from speculative finance, is something I’ve been hearing in a good deal of British thought on financial regulation. I expect American policy makers to catch up soon.