On the other hand Lowenstein points out (and I agree, with qualifications) that the financial industry is different because of its impact on the economy. There are examples were regulation has been helpful especially were the regulation seeks to increase transparency. In this regard the failure to require derivatives to be traded on regulated exchanges is a big mistake.The financial industry is indeed different. The biggest difference between, say, trucking and banking are the externalities.If a big trucking company goes down, its competitors benefit as they take over its market share. If a big bank goes down, it has negative effects on the rest of the banking sector:1. The bankrupcy decreases the confidence of creditors and customers of the other banks, which may lead to the withdrawal of debt capital (in the worst case, a bank run)2. As the assets of the bankrupt bank are sold off, this decreases the value of the assets of its competitors. In the trucking industry, a short-term decline in the realizable value of its assets due to the liquidation of a competitor are irrelevant. In the banking sector, however....3. As banks get into difficulty, they scramble for liquidity and capital. This makes it difficult for other banks to get liquidity and capital.These external effects lead to the cyclical nature of credit meltdowns - during normal times, the banks that take the most risk grow fastest.And as long as the sector as a whole is acting conservatively and cautiously, any single bank that leverages up is not actually risking meltdown, because even if there is an unexpected downturn, there is no scramble for liquidity, asset prices don't drop that much, and even the risk taking banks do ok.However, as the cycle wears on, the risk takers (which grow faster than the conservatives and also look a lot more successful) start to dominate the market. Then, eventually, a downturn turns into a credit crunch and a meltdown.But the next time is not going to be different there are no laws that we can past that will end the bubbles and crashes. The best we should hope for is to cut back on the level of damage.It's not difficult to prevent the banking sector from blowing itself up.All you need are regulators which are not captured and understand that the banking sector is always trying to blow itself up.Regulators that get worried when the banks are making a lot of money. Regulators that don't look at the financial sector with glowing admiration but rather with wary caution.Eventually, the lesson will be learned, and economic science will once and for all understand the financial disaster cycle. Not this time, of course, but maybe next time. The problem is that America and the American government cannot afford a next time.Here's how a meltdown was prevented in India:http://www.nytimes.com/2008/12/20/business/20nocera.html?pag...
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