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Tuesday, February 16, 2010

It's Time for Financial Reform

Alan Blinder says we'll be lucky if anything at all is done to reform the financial system and at this point he'll settle for two things, better oversight of systemic risk and resolution authority for systemically important firms:

It's Time for Financial Reform Plan C, by Alan S. Blinder, Commentary, WSJ: About a month ago on this page..., I worried that the financial reform boat was taking on water and in danger of sinking. Since then, legislative prospects have grown progressively worse.
First came the election of Sen. Scott Brown (R., Mass.)... Then came the Supreme Court's outrageous campaign-finance decision, which will strengthen the hands of industry lobbyists... Finally,... Republican senators slammed the door on any bipartisan reform bill, embracing yet again the "just say no" strategy.
Doing nothing to safeguard the financial system after what we've been through would be a disgrace. So what can be salvaged from the wreckage? Let me start with the two most pressing issues: systemic risk and resolution authority.
I don't think any sentient person denies the need for an agency responsible for overseeing system-wide risks... The disagreements come over to whom to give this authority. I have long thought it should be lodged in the Federal Reserve. ... There is good news here. If Congress fails to act, the Fed will, by default, continue to be the tacit systemic risk monitor and regulator. ...
Not so with resolution authority. ... Here we do need a legislative fix... Rumor has it that Republicans and Democrats on the Senate Banking Committee are—or is it were?—close to agreement on this thorny-but-essential issue. Ladies and gentlemen, could you possibly stop bickering long enough to give us a tightly-focused bill that accomplishes this one objective? Mr. Obama, could you please shame Congress into doing so?
Next on my reform list would be the proposed Consumer Financial Protection Agency (CFPA). It is clear that one major contributor to the subprime mess was that unwary consumers were duped into mortgage products they should never have touched. And it can happen again. So I think the CFPA is an essential addition to the regulatory tool kit. But hardly any Republicans agree. My advice on this one to Democrats? Demagogue the issue unmercifully. Portray Republicans as defenders of those who would cheat consumers and permit another subprime debacle. My advice to Republicans? Cave in...
That brings me to the Volcker rule on proprietary trading... I could not agree more with his underlying goal: to stop traders from gambling with taxpayers' money.
That said, I am waiting to see if what is really the Volcker "idea" can be translated into a workable Volcker rule. It is devilishly difficult to draw bright lines between proprietary trading and trading, hedging, and market-making on behalf of clients. Mr. Volcker himself said that "you know it when you see it," suggesting an analogy with pornography. The problem is, often you don't. ...
There are many other financial reform issues, but my space and your attention are limited. The overriding message is this. Plan A died long ago, and Plan B is gasping for breath. It's time to prepare Plan C.

Hank Paulson agrees:

How to Watch the Banks, by Henry Paulson, Commentary, NY Times: Sixteen months ago, our financial system teetered on the brink of collapse. The Treasury, the Federal Reserve and the Federal Deposit Insurance Corporation took actions that were unpopular and previously unthinkable — but absolutely necessary to stave off an economic catastrophe in which unemployment could have exceeded the 25 percent level of the Great Depression.
These temporary actions have ended or will end. And our financial system is much more stable. But it is critical that we learn from the financial crisis and put in place reforms to avert a repeat of 2008 or something even worse.
Congress must pass financial regulatory reform. Delays are creating uncertainty, undermining the ability of financial institutions to increase lending to the businesses of all sizes that want to invest and fuel our recovery. Our overriding goal in restructuring our financial architecture should be that taxpayers never again have to save a failing financial institution. ...
This calls for two vital changes. First, we must create a systemic risk regulator... Second, the government must have resolution authority to impose an orderly liquidation on any failing financial institution to minimize its impact on the rest of the system. ...
A single agency responsible for systemic risk would be accountable in a way that no regulator was in the run-up to the 2008 crisis. ... My preference is for the Federal Reserve to be the systemic risk regulator, because the responsibility for identifying and limiting potential problems is a natural complement to its role in monetary policy.
Congress, however, seems to be moving toward having a council of regulators perform this function. While that is not my preference, I believe a council can be workable if it is led by either the Treasury secretary or the Fed chairman, and is structured to ensure that strong decisions are reached quickly in a crisis. Too many such panels in government act by consensus, allowing a single member to render the council immobile. ...

Limits on leverage would be one of my "two vital changes."

Congress will do something. Voters expect it and they'll deliver. The question is whether the changes they make will have any teeth, and whether they'll be directed at the right problems. I don't expect, when all is said and done, that reform advocates will be pleased with the outcome. Congress will do enough to satisfy voters, but the will to enact the kind of fundamental change the system needs doesn't seem to be present. Given the close relationship between congress and the financial industry, it's not hard to think of reasons why that might be the case.

    Posted by on Tuesday, February 16, 2010 at 12:45 AM in Economics, Financial System, Politics, Regulation | Permalink  Comments (57)


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