The Proposed Financial Reform Would Be A Mistake

Professor Peter Morici is strongly critical of the bank regulatory reform bills that are currently being considered by Congress. Some of the problems he points out in the proposed legislation are placing power in the wrong hands and not sufficiently protecting against systemic risk. See the following from from The Street.

The sweeping bank regulatory reform bills introduced in the House and Senate focus too much on who does what -- reorganizing who regulates what banks and which activities.

Those bills would regulate banks badly by imposing too many costly requirements instead of improving the principles of good banking practice and risk management.

For example, having a council of regulators on systemic risk and oversight is a terrible mistake -- either it will be management by committee (an interagency group that reaches consensus slowly and badly in crises) or it will be dominated by its chairperson, who will be engaged in tugs of war with the Fed chairman at times when decisive, surgical and dramatic action is required.

Ultimately, the Fed must provide the resources for resolution of failing entities having systemic consequences -- disasters the size of Lehman or AIG(AIG Quote) -- because no fund envisioned by taxing big firms will be big enough.

The FDIC already collects such a tax from banks (FDIC insurance premiums), and that fund has proven to be too small for the failures of regional banks. In the end, the Fed must provide the money.

Will this new systemic risk panel force the Fed to print it? It is a terrible idea to put those powers into the hands of a more political body.

The consolidation of Controller of the Currency and the Office of Thrift Supervision is smart, but consumer protection belongs in the new agency, too. If consumer protection is put in a separate agency, then the health of the banks in the regulation of things such as community lending mandates will be ignored --congressional mandates were among the principal causes of the Fannie Mae (FNM Quote) failure. A political appointee will make banks do reckless things and create all kinds of problems.

Proposed legislation envisions taxing and micromanaging banks, instead of relying on: stronger capital requirements; insulating (separating) the banks from the casino, and establishing principals of good practice that should guide the decisions of regulators and bankers alike.

Instead:

• Leave general bank holding-company oversight and systemic risk regulation at the Fed, and consolidate other bank regulation and consumer protection. Give the Fed resolution authority for entities too large or complex for the FDIC to handle.

• Stronger capital requirements -- that's motherhood.

• Separate commercial bank balance sheets/assets from those of investment banks, hedge funds, etc. Base banking compensation solely on banking activities -- that will solve the compensation issue privately if commercial bank investments in securities and the derivatives market are adequately reformed.

• Don't bring back Glass Steagall, but do limit the scope of acceptable securities that may back up bank deposits -- get banks out of betting on securities, which was a major problem at regional banks as well on Wall Street.

• Require adequate assets to secure derivatives contracts -- something that was woefully lacking at AIG, Lehman etc. More than reporting, that will help reduce abuses in derivatives trading and their threat to systemic stability.

• Reform lending practices, which is already happening thanks to Federal Reserve action.

This post has been republished from The Street, an investment news and analysis site.