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Monday, August 17, 2015

Greenspan: Shelve Dodd-Frank

We should listen to Alan Greenspan on bank regulation, especially regulation of the shadow banking sector. After all, he was the one who argued we didn't need to worry about financial markets because the market would force them to self-regulate.

We all know how that turned out, including Greenspan's famous mea culpa on this issue. Greenspan says, as though we should listen, that Dodd-Frank financial reform needs to be reversed:

Higher reserves will secure the financial system with less pain, by Alan Greenspan, Commentary, Financial Times: ... What the 2008 crisis exposed was a fragile underpinning of a highly leveraged financial system. Had bank capital been adequate and fraud statutes been more vigorously enforced, the crisis would very likely have been a financial episode of only passing consequence.
If average bank capital in 2008 had been, say, 20 or even 30 per cent of assets (instead of the recent levels of 10 to 11 per cent), serial debt default contagion would arguably never have been triggered. ...
Lawmakers and regulators, given elevated capital buffers, need to be far less concerned about the quality of the banks’ loan and securities portfolios since any losses would be absorbed by shareholders, not taxpayers. This would enable the Dodd-Frank Act on financial regulation of 2010 to be shelved, ending its potential to distort the markets — a potential seen in the recent decline in market liquidity and flexibility. ...

Actually, I agree on higher capital requirements, but we depart when he asserts that is all that is needed. In any case, had he been willing to push for something like this when he had control of the policy levers instead of steadfastly standing against it with a 'markets are always right' argument, maybe things turn out better.

Note: On his assertion about the recent decline in bond market liquidity, the NY Fed says:

Overall, our evidence is fairly favorable about the current state of Treasury market liquidity. Direct measures such as the bid-ask spread point toward liquidity that is quite good by recent historical standards. Other measures such as quote depth and price impact imply some recent deterioration in liquidity, albeit from unusually liquid conditions. The evidence suggests that market participants’ liquidity concerns are not emanating from average levels of liquidity in the benchmark Treasury notes.

If average liquidity is generally good by historical standards, then why all the liquidity concerns? ...

I'll take a shot at answering that. Could it be a means to attack Dodd-Frank, and regulation more generally?

Two other observers, Cecchetti & Schoenholtz, also look at bond market liquidity:

...when knowledgeable people express concerns that regulatory changes are causing bond markets to malfunction (see, for example, here), it leads us to ask some tough questions. Are these markets somehow impaired? Is enhanced financial regulation to blame? Is this creating risks to the financial system as a whole?

To anticipate our conclusion, while bond markets are clearly evolving, we do not see reasons for immediate concern about the financial system as a whole. In fact, our expectation is that the capital and liquidity requirements that have made financial intermediaries more resilient to economic downturns and to interest rate spikes, also have improved their ability to stabilize bond markets. ...

Put another way, better regulation has removed the public subsidy to trading activity that banks and others were able to capture prior to the crisis...

    Posted by on Monday, August 17, 2015 at 10:33 AM Permalink  Comments (29)


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