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And Now, On to Financial Reform . . .

Posted By Barry Ritholtz On March 22, 2010 @ 7:26 am In Bailouts,Credit,Regulation | Comments Disabled

With Health Care now out of the way, we can get to what I consider to be the more important issue: Reforming Wall Street and the banking sector.

As I noted 6 months ago, the White House emphasis on Health Care over Finance was a significant tactical error [1]. I would imagine with their weekend health care victory, the White House might push for finance reform. I expect they will see some significant traction.

I do not know what the political fall out from being for or against health care will be. But I can tell you that it will be much harder to oppose re-regulating banking. While the banks have succeeded in buying Congress, I think their attempts to stop a major overhaul of financial regulation will be far more difficult. Political opponents will paint anti-reformers as pro-banks and anti-family.

Ideally, what should that overhaul look like? I can identify at least six areas that need total overhaul:

1. The Ratings Agencies: The prime enablers of the crisis, their pay-for-play business model is a debacle. Their status as Nationally Recognized Statistical Rating Organization (NRSRO) should be stripped, and the space opened up for real competition.

2. Derivatives Must Be Regulated like all Financial Products: Put derivatives on exchanges; require counter-party disclosure and transparent open interest reporting. Capital requirements for trading is needed — and like other insurance products, there should be reserves for losses; Lastly, we should repeal the CFMA.

3. Regulate Non Banks lenders like Banks:  The unregulated non-bank lenders were at the heart of this crisis. It doesn’t matter if you aren’t a depository institution, if you loan money, you must be regulated like any other bank PERIOD.

4. Reinstate Net Cap Leverage Rules:  Over turn the SEC Bear Stearns exemption via Congress. Reinstate the former 12-to-1 leverage rules.

5. Eliminate Too Big To Fail:  Nixon Treasury Secretary George Shultz famously said “If they are too big to fail, make them smaller.”  Put caps on percentage of total US assets allowed. I suggest 1%. Break up insolvent, incompetent megabanks — like Citi and Bank of America. And I would carve up JPM as well. Separate the Depository Banks from the investing houses. (restoring Glass-Steagall will do that).

6. Do not give the Federal Reserve MORE Authority:  The Fed should focus on monetary policy. They can work closely with whoever is ultimately the bank regulator — but I do not believe having them be be the prime over seer of banks can work.

7. Stop Regulatory Forum Shopping:  The alphabet soup of various bank regulators OTS, FDIC, OCC, etc. should be replaced with one regulator. The FDIC is the only office that did a good job this entire crisis, put all regulatory responsibility under Sheila Bair’s office.

8. Overhaul the SEC:  They need to have numerous improvements: Start by making them less of a law firm and more of a finance shop. Expand the hotline/whistleblower division, offer bounties for discovering and reporting fraud. Add a quantitative division to look for issues mathematically.

9. Reform Compensation:  The system of privatized gains, socialized losses must be thwarted. Exec compensation is totally disconnected from their performance. Major overhaul from shareholders is needed. Require custodians — Mutual funds, pension plans, etc. — to vote their holdings (shares) as a fiduciary.

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Essentially, I am advocating a “Do Over.” Reverse the past 3 decades of radical deregulation. The alternative is an even bigger financial crisis, and sooner than you imagine.

The next time around, I plan on watching it all unfold from St. Barts . . .


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[1] tactical error: http://www.ritholtz.com/blog/2009/09/finance-reform-vs-health-care-reform/

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