Tim Carney likes my financial reform ideas, but Ken Rogoff does not. Rogoff writes,

A surprising number of pundits seem to think that if one could only break up the big banks, governments would be far more resilient to bailouts, and the whole “moral hazard” problem would be muted.

That logic is dubious, given how many similar crises have hit widely differing systems over the centuries. A systemic crisis that simultaneously hits a large number of medium-sized banks would put just as much pressure on governments to bail out the system as would a crisis that hits a couple of large banks.

I agree. But the question is whether a large number of medium-sized banks could shape the contours of the regulatory system to their benefit (and to the taxpayers’ detriment) as successfully as a few large Wall Street firms have. Even now, Wall Street is drooling over the prospect of a mortgage finance system in which Freddie and Fannie guarantee all mortgages but are not allowed to hold securities in portfolio, leaving Wall Street free to carve up and trade these securities in all sorts of ways, making yet more profits by exploiting their too-big-to-fail status and other regulatory anomalies.

Rogoff continues,

some finance specialists favor forcing banks to rely much more on “contingent” debt that can be forcibly converted to (possibly worthless) stock in the event of a system-wide meltdown. But how this form of “pre-packaged bankruptcy” could be implemented in a world of widely different legal, political, and banking systems is unclear. Financial history is littered with untested safety-net devices that failed in a crisis. Better to rein in the growth of the system.

Again, I agree. It is very hard for policy makers to credibly commit themselves to allowing an untried bankruptcy system to run its course. They will always be tempted to say, “Not on my watch,” and to try to bail banks out instead.

I think that leverage is always dangerous. That is why proposals include changing all of the policies that produce biases in favor of debt finance, from the mortgage interest deduction to the corporate income tax.

The way I look at it, there is no perfect solution for financial reform. Rogoff favors an IMF idea, which is to tax bank size. My concern is that this would tighten the symbiosis between governments and large banks. It would give banks the ability to say, “Hey, we paid the tax. Now you owe us the bailout.” It would give governments a reason to want to favor big banks–in order to collect more revenues.

I could see a tax on bank size opening up avenues for all sorts of mischief. How long would it take for Congress to enact a tax break for large banks that make lots of loans to favored political constituents, say…low-down-payment mortgages to low-income homebuyers?

(To be honest here, Rogoff is probably was not writing about my proposals. My guess is that he was taking on Simon Johnson and James Kwak on the “break up the banks” issue, and he is taking on Luigi Zingales on the “contingent debt” issue.)