Simon Johnson argues that the Bassel III negotiations from last year resulted in lower capital requirements which was folly, and now exposes the European banks to great risk. What do you think?
Along these lines, at the recent HES meetings I had the occasion to speak with Perry Mehrling, the author of The New Lombard Street (among many other works, e.g., his excellent biography on Fischer Black). Perry argues that free market types like myself ask the wrong question when we focus on letting the banks fail and thinking about decoupling the links that cause counter-party contagion. At a fundamental level, he argues the international credit system is not characterized by counter-parties, but by an intricate interwoven web of interlocked balance sheets. You cannot decouple, and thus a bank failure here results in a crash over there. My response, for sake of argument, was that this resulted in an extremely fragile international financial system, and thus I asked the question back to him --- how do we make the system more robust? And especially given the system and the politics involved, how would we ever overcome the permanent moral hazard the system as he describes it creates? I didn't get a concrete answer.
Though at some level this is what Nassim Taleb is asking as well, also see him discuss this idea: