Financial Reform thoughts…

I have been asked about my thoughts on financial reform so let me put down some thoughts.  First, I was supportive of the bailout efforts in 2008/2009 not because I cared about Wall Street banks, but because a multi-decade economic collapse was going to be bad for everyone. As difficult as it was to ‘save the banks’, I thought (and still do) that it was the best of a bunch of lousy options. I think the recovery reinforces that view, but since we did not experience the alternative, that is difficult to argue.

I cannot fathom that having gone through the financial collapse, there is anyone on the planet that does not want major changes on wall street. Here are a few of them I think make sense:

Close the Casino  I heard Michael Lewis say this and I think it is a good guiding principle and excellent talking point. No more highly levered, off-balance-sheet, exotic, black-box trading operations. You can be an investment bank or you can be a hedge fund. Make your choice. If you are going to be a primary dealer of the Federal Reserve and take deposits from citizens and conduct investment banking operations, you cannot run a hedge fund in the basement. You also cannot trade the securities that you make a market in. Too many ethical issues for ultra smart 20-something’s to make.

Regulation We had a lot of regulations removed in the 90s and 00s that did not need to be removed. A reasonable limit on leverage ratios ( well below 30-1 or 40-1 ) make obvious sense. An up-tick rule on shorting is simple enough. Everyone says it is ineffective, so no reason to not do it. Some limit on why a person might buy CDS as something other than a speculative bet might make sense. It also makes sense that if you are going to buy or sell a derivative which is essentially an insurance policy, that you hold either an offsetting position or a sizable reserve to cover the eventual payment (AIG clause). I remember well the circular linkage between buying the CDS, shorting the stock, wait for the credit agencies to downgrade the company, rinse/wash/repeat.  In a fractional banking system, a perfectly healthy bank is still susceptible to a run on the bank. In our markets, we should put up barriers to it occurring, not encourage this behavior.

Exchange/Transparency  This is a no brainer. One of the obvious problems throughout the crisis is nobody seemed to know the exposure of any bank’s books. It should be very simple at the end of each day – or intraday – to know the exposure of each financial institution. Open exchanges make sense, and anything that trades in the billions to trillions of dollars should be on an exchange.

What are the decoys? I am not overly concerned about Too Big Too Fail from a balance sheet size standpoint. I do not think size in and of itself caused the problem. Canada’s banks perfectly illustrate this. It was caused by complexity, leverage, inadequate reserves, and lack of regulatory oversight. Compensation is another non-starter. I see no way for regulators to control private sector compensation, nor should they.  I am supportive of changes to corporate boards, but not in this initial legislation. I am a supporter of term limits as I realize the only way elected officials will do what is right, which is often unpopular, is if they are not running for re-election.

We suffered the downturn. We backstopped the recovery. We deserve reform to prevent it from happening again for at least another 80 years. Tell your elected officials to make it happen. If they do not, vote them out of office.

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