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What the economists say - US financial sector regulation

Over at FT’s Economists’ Forum some of the world’s finest economic minds debate lucidly, if lengthily, on the issues raised in columns by Martin Wolf and economics contributors such as Larry Summers and Willem Buiter.

In this occasional series we will bring you a summary of the discussion for busy Alphaville readers who might find it a bit tldr.

In his column last week Martin Wolf argued that it was intellectually untenable for Wall Street to resist more onerous regulation of capital requirements or liquidity. Moral hazard is already visible, he wrote, in the jump of investment banks’ share prices since the Bear Stearns rescue.

Ricardo Hausmann argues that tighter regulation during the past few years would not necessarily have led to better pricing of risk. He would put the blame on “a so-called Taylor rule - that sets the interest rate as low as possible, so long as the discomfort with inflation is not larger than the discomfort with unemployment”.

Robert Wade points out that a “new financial architecture” was discussed after the financial crises in in Mexico (1994–5) and East Asia/Brazil/Russia (1997–8) — but by 2000, when these crises appeared limited to the emerging markets, “discussion petered out”.

Just when you thought things could not get much worse, Guillermo Calvo warns that the current financial crisis could be distracting us from another problem: a reduction in central banks’ ability to anchor nominal prices. “In the short run this may be less noticeable in broad price indexes like the CPI but, in my view, it is already being reflected in, for instance, the dollar/euro exchange rate,” Calvo argues. This could have a deleterious effect on trade, he says, because while public policy can respond to trading partners’ technical superiority, for example — it is difficult to effectively reform against arbitrary swings in exchange rates.

Adam Posen echoes Martin’s fears that the current crisis will be interpreted by countries such as China and India as a strike against free market liberalisation. But he fears the misinterpretation will go further. “Life is complicated, so events get overdetermined.” The outcome could be an even deeper rejection of liberalisation, as the entire “anglo-saxon model” is blamed for what Posen calls a “regulatory ankle-sprain”.

The Fed has of course taken on much of Bear Stearn’s credit risk, and last week expanded its emergency lending to primary dealers. So what will Wolf and the economic pundits make of the financial regulation revamp, to be announced later today - which proposes enhanced supervision of investment banks on a temporary, rather than permanent basis?

This entry was posted by Kate Mackenzie on Monday, March 31st, 2008 at 12:50 and is filed under Capital markets. Tagged with , , , , . You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.

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Comments

  1. Mar 31   16:16 Posted by wdm [report]

    No one with any sense would listen to the lame ducks in Washington.
    Paulson, Greenspan, Dimon, Bernanke, MER, C, BAC, UBS, MS, GS, CS, BARC, all the rest who presided over the drunken orgy that left the global financial system bankrupt will be fortunate to avoid prison time for the carefully planned and orchestrated fraud.

  2. Mar 31   14:42 Posted by Anonymous [report]

    The Good Citizen Fund: Proposal For Private Regulation Of The Financial Sector
    These four ‘instant reforms’ could be implemented tomorrow morning by regulators of banks, GSE’s, exchanges, and broker/dealers. At first, compliance with the reforms would be voluntary, but they will be made legal and binding as quickly as possible.

    1) No credit extensions to entities which do not agree to reforms
    2) Stricter minimum margin rules for credit extensions (sliding scale from 2%)
    3) No new off-balance sheet items unless exchange-traded or very collateralized
    4) No more netting of trades unless settlement date is within 30 calendar days.

    How To Enforce The Reforms?
    Banks, GSE’s, exchanges and broker/dealers that agree to comply with the four reforms will be listed immediately on the Fed’s public website. The website will include a warnings and notices as follows:

    WARNING: AN UNLISTED FIRM MAY NOT BE ELIGIBLE FOR ACCESS TO THE FEDERAL RESERVE

    The listed firms below have agreed not do business with unlisted banks, GSE’s, exchanges and broker/dealers after April 30 and to implement certain reforms.

    Good Citizen Awards: If your employer is listed and you know of any violation which occurred after April 30, you should inform your immediate supervisor about your concerns. If the violation continues after another week after notifying your supervisor, please report the violation to the Federal Reserve Bank at 800-000-000. Your privacy will be protected.

    If inspectors find the reported violation exists — or that you had good reason to suspect one — you will receive a $10,000 (or more) Good Citizen reward. If the inspectors find the suspected violation did not occur, no action will be taken against you or your firm. But always act in good faith.

    If a firm incurs a second violation, it may pay a $1 million penalty in order to remain on the ‘reformer list’ or choose to delist and not pay the penalty.

    Subsequent violations will carry a penalty of $5 million each. All violations, penalties paid, and voluntary delistings will be noted at the site.

    If a firm does not agree to comply with the voluntary reforms by April 30, the Fed will consider a ‘bad faith’ market participant and may deny it access to repo, the discount window and other financial support. Further, if a firm fails to meet the April 30 listing deadline, it will not be added to the eligible ‘reformer’ list before June 1 (and on monthly dates thereafter).

    Any firm with more than $10 billion in assets that elects not to be a ‘reformer’ will be listed separately with the following warning:

    THESE FIRMS ARE UNSUITABLE COUNTERPARTIES FOR MEMBERS OF THE PRIVATE REFORM MOVEMENT

    These firms with assets over $10 billion have elected not to join the voluntary reform movement of the financial sector. Therefore, members of the reformerer group will not conduct any business with the entities list below:

    End of Federal Reserve Message.

    To implement the plan, the Fed simply sets up
    (1) a telephone number and recorder to take reports of suspected violations
    (2) appointed approriate staff to handle the phones
    (3) open a ’special purpose’ account to handle Good Citizen income and expenses

    Private Regulation Of The Financial Sector
    The proposed new regulatory company will be a private company (’Good Citizen’) authorized by Congress to oversee compliance of existing regulatory framework of the financial sector, propose new regulations and changes, and to provide ‘bailout’ insurance.

    Good Citizen will be organized along the lines of a mutual insurance company and funded by tax-deductible premiums based on total employee compensation (especially bonus payments). We envision as much as 25% annually, but with a generous dividend after two years experience. The company will have a small staff to gather reports of possible infractions and coordinate remedies with existing regulators.

    Participants in the financial sector must purchase an insurance policy and agree to comply with its conditions. Transactions with uninsured parties in the financial sector are not permitted.

    The financial sector includes entities which conduct business in securities (securities will be very broadly defined) including banks, broker/dealers, exchanges, inter-dealer brokers, leveraged hedge funds and private entities, insurance companies offering credit enhancements for securities and counterparties. Affiliated companies or closely-tied entities which are at least 20% owned (actual, constructive or contingent) must also be insured. This includes all ‘off-shore’ and international subsidiaries and affliates.

    There will a very generous reward system for Good Citizens, including payments for ‘good-faith’ false alarms. Good Citizens will be anonyomous and their privacy protected.

    There will be incentives and dividends for faithful compliance and cooperation. There will also monetary penalties for infractions including the ‘death penalty’ cancellation of the policy.

    Non-US Companies and Entities
    Central banks and regulatory authorities outside the US will be asked to cooperate with the spirit of the Good Citizen program and not permit ‘loophole’ competition that disadvantages members of the reform movement. Reformers will be encourage to inform the Good Citizen company of foreign abuses and the company will follow through with Congress and other US regulators.

    –
    William Kidder
    Email: bill@kidderreports.com
    Worldwide Phone Number: 646-257-2130
    My website is www.KidderReports.com

  3. Mar 31   13:41 Posted by Pat Lee [report]

    Regulation has it’s place but is not the total answer, it must be installed with balance and great common sense.The US crisis has great effect on the rest of the world. the UK is heavily regulated but this has not saved it. Recently the mortgage market is similar to the 1980’s. Firstly my sites http://www.mortgagebestrate.co.uk/ and http://www.mortgagehome.co.uk/ which has good ranking has now no inquiries, secondly there are now much fewer mortgage products and thirdly lenders do not want to lend.

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