Some quick thoughts- Prudential and consumer regulations as a preferential tool for controlling bank money creation?

This quote from the Levy Institute’s recent paper entitled “Federal Reserve Bank Governance and Independence During Financial Crisis” really got me thinking:

 “Excessive private credit creation was the key policy challenge facing the Fed after WW2. The Truman Administration ran budget surpluses for several years, but strong bank lending neutralized their effects. The banks, in other words, created an amount of money just about as fast as the Federal Government, through its fiscal policy, contracted the money supply. "

MMT talks a lot about how the creation of bank money affects aggregate demand, and how permanent zero rates might be a good idea going forward. I think we should also begin discussing how growth in bank money might be controlled in this permanent zero environment. It seems to me that if raising interest rates to slow down lending is off the table, then we would need to have other tools available. Since I have been working in financial regulations for a while now, I have come to see firsthand the truth of MMT’s claim that regulations, not interest rates, truly affect lending. And anecdotally, I frequently hear compliance people complaining about how all the new Dodd-Frank rules are curtailing lending. So here are some of my preliminary thoughts on this issue: 

• The last few decades have demonstrated the failure of traditional monetary policy tools to control growth in the money supply

• We know that the Fed controls only price of required reserves, and cannot directly control quantities of bank money, since this growth is mostly demand based

• Central banks are moving away from reserve requirements and monetary aggregate targeting anyway. Cant’ push on a string during times of low loan demand

• Inflation can be caused by excessive and imprudent lending. It’s not always due to too much horizontal money creation by federal deficit spending (although its remarkable that the explosion of bad lending and large deficits of the Bush admin were *still* not enough to create inflation)

• Using interest rates to manage an economy has mostly failed, and created enormous side effects:
• Market volatility
• Creates unnecessary interest rate risk burdens for depository institutions (cost of short term funding goes up, while long term assets are fixed)
• Creates risk of deposit flight from traditional banking system into higher yielding shadow banking/money markets which are not as closely regulated or monitored

My premise is that:

• Consumer and prudential regulations can be a much more effective and precise way of reducing lending-based creation of bank money (M2), than the tradition tool of raising interest rates

• Question is how do you develop a regulatory regime that is flexible enough to be ratcheted up or down for macroeconomic needs?

• Housing finance is a major source of bank money growth and therefore aggregate demand, so it is a good place to focus, using these tools:
• Raising/lowering agency (Fannie, Freddie, FHA, VA) conforming loan limits (very influential in housing esp. now that they control so much of the market)
• Weighing of risk-based bank capital 
• Risk retention/QRM rules from the prudential regulators
• Qualified Mortgage standards from CFPB

• From the firm perspective, these changes would:
• Increase compliance risk/burdens (bad for banks)
• But decrease volatility/interest rate risk, if rates are permanently kept at zero (good for banks)

Therefore-- 

With the end goal being full employment, the primary focus of federal financial/fiscal policymakers should be to strike the right balance between US dollar creation via federal deficits, and bank money creation via net bank lending. Both of these money creation forces contribute to aggregate demand, and if they outstrip the ability of the nation to produce a commensurate level of real goods and services, can cause an undesirable rise in the price level. Policymakers should approach full employment with as much of a utilitarian mindset as possible-- the only “moral” issues that should be taken into consideration here are the deleterious social effects of involuntary unemployment. 

Thoughts?