This is a profound shift in priorities -- the banking sector was normally governed on the basis that the best outcome was increased profit-making opportunity. The Obama administration, with its predilection for increased regulation, realizes that the best outcome for the banking industry, its executives and its shareholders is not necessarily the best outcome for the nation as a whole. It is interesting that the only major change to Fed policy was with respect to its bailout of AIG. The Federal Reserve Bank of New York funneled AIG $85 billion to keep that company out of bankruptcy, a move seen as essential to the preservation of the global financial system. Necessary or not, the move was unprecedented and marked new territory for Fed policy. The Fed's approach to monetary policy, on the other hand, has not changed. They have attempted to stimulate the economy through interest rate cuts. This move failed because it occurred at a point where banks had no money to lend and consumers had no confidence to borrow. Worse, it was a repeat of the policy in 2001 that played such a major role in the development of the subprime crisis in the first place. Thus, there is the real risk that if the Fed does not increase rates early in the recovery process, the economy could be poised for yet another bubble.

The increasingly complexity of the banking business caught the government by surprised. Waves of deregulation had increased the volatility of the banking sector and for a time this resulted in increased profits. The thing about volatility is that the movements are just as intense going down as they are going up. The federal government had traditionally felt that intervention was a rare occurrence, and not too damaging to the economy. However, this current crisis has proved the opposite. The economy is devastated, and the impacts of the trillions of dollars of bailout funding will be felt for years or even decades in the form of higher interest rates and a higher cost of government borrowing. The federal government is now oriented away from unfettered free markets in the banking sector, recognizing the fundamental truth that nobody minds increased risk when it results in increased profits, but few people have the stomach for the downside of that risk.

The shift in outlook of the federal government -- both the Bush and Obama administrations -- shows the severity of the crisis. The response, after all, has been severe. It remains to be seen the degree to which the government will increase regulation on the banks. If regulation increases sharply, it will reflect...

If regulations do not increase sharply, then this will signal that the shifts in policy were temporary and crisis-driven. The Fed, on the other hand, does not appear to have learned its lessons from the crisis, as they have adopted precisely the same interest rate policy that contributed to the problem in the first place.
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