Financial Regulation – Principles

This morning I am watching CSPAN's coverage of US Treasury Secretary Geithner at a House Committee on Financial Services hearing on financial regulation and systemic risk. Watch Geithner's opening statment here (via Yahoo! News).

Yesterday, over at Mother Jones Kevin Drum laid out some principles to guide new financial regulation. Drum suggested three and asked readers for more:

- Firmer Regulation Over Leverage, wherever and however it occurs. [To increase] capital adequacy ratios, … lead to similar oversight of hedge funds; ̷ overhaul how capital and assets are calculated; [regulate] effective leverage embedded in complex derivatives; [add] rules about off-balance-sheet vehicles; and so forth.

- Stronger Commitment to Act Countercyclically. …to force the Fed to keep an eye on asset inflation as well as goods inflation; a dedication to limiting credit expansion as well as credit destruction; capital adequacy rules that weren't merely stronger, but that tightened during expansions and loosened during contractions; and stronger down payment requirements for mortgage loans.

- A recognition that the global financial system could stand to have a little more sand in its gears. Something to slow it down just a little bit, … like a small transaction tax [Iverson here: e.g. a Tobin Tax (Wiki link) -- that could act in part as an insurance premium to tax payers against the risk that the tax payer will be required to bail them out]; exchange trading for credit derivatives; and stronger transparency rules.

Here is a combined "Eight Regulatory Principles" list, edited slightly:

• Firmer Regulation Over Leverage, (wherever and however it occurs, e.g. higher capital and margin (leverage) requirements that might be even higher for very large firms/entities that pose potential systemic risk)
• Stronger Commitment to Act Countercyclically (to lean against the wind during both "irrational exuberance" and "irrational pessimism", including adding "asset bubbles to diagostic toolkit)
• Better Control of Cross-border Capital Flows
• Better Firewalls Between Financial Businesses
• Holding Credit Rating Agencies and Auditors Accountable for their Judgments
• Making Financial Transactions as Transparent as Possible (like making them exchange traded, or having adequate clearing houses outside exchanges)
• Better Means to Discourage Speculative-runs-to-ruin (on corporations that show signs of relative weakness during market breakdowns)
• Reformed Incentives for Financial Executives, large in-house traders, etc. (e.g. require some bonuses to be paid in restricted stock that can only be liquidated in say 10 years.)
  

One of Drum's reader suggested three tactical moves. I'll add a fourth:

- Reinstate the Glass-Steagall Act in its final form (prior to repeal)
- Repeal the Gramm-Leach-Bliley Act
- Repeal Commodity Futures Modernization Act of 2000, which enabled unregulated market in credit default swaps, among other things
- Develop more flexibility in"Fair Value Accounting", mark-to-market accounting (e.g. to disallow entities to appear ever-more-wounded during bear raids)

From written testimony and verbal responses to questions, it looks to me like Geithner and Co. intend to cover most if not all the bases outlined in the principles above. But intentions must turn to action! We need to keep watch, as well as to add voice to make for better regulation, better action, and better oversight not only of government but of the private entities entrusted with our money.

PS. In March 23 WSJ online, George Soros offers insight into "Means to Discourage Speculative-runs-to-ruin" by regulating Credit Default Swaps.

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Update, 3/19/2011: Today, in Stop Killing Messengers, I added two more:

• Protecting Rewarding Whistleblowers
• Hiring High-power Talent

Finally, I'll add that I really don't support reinstating Glass-Steagall, but instead creating a modern version of it.

Comments

[jaycee]

How about requiring all communications between regulators and Congress and industry to be restricted to public forums and the substance of all such communications must be made public, preferably posted on the net. Congressional and interest group meddling in regulatory affairs is usually at the top of the list of causes of disasters like this (it certainly was a factor in the S&L mess). It's a difficult problem to deal with since Congress funds and creates the regulators but it's something that needs more thought than it's getting.

[Stuhlmann]

How about any business that guarantees/promises a financial outcome, whether a bank, an insurance company, a casino, or hedge fund selling CDSs, has to keep a certain amount of funds on hand to cover the promised outcomes.

[Michelle Boudreau]

Financial regulations and principles help improve the credit ratings of business institutes , they improve the position on the competitive phase between different companies .

[Danny L. McDaniel]

Before the economy and financial institutions can be prudently regulated it requires competent professionals and factual data and information. Both have been lacking in the United States for decades. It is a wonder we are not in worse shape than we find ourselves. Or maybe we are but no one has the correct information to tell us. Either way, political spin is as common on Wall Street as it is in the halls of Congress and the White House.

As Warren Buffet once said when you hire someone "they should be energetic, imagative, and moral. If you don't have the last one, the first two will kill you."

Danny L. McDaniel
Lafayette, Indiana