Recently in Published Opeds on Financial Reform Category

Reshaping the banks has only just begun

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The US media has been buzzing with reviews and comments about William D Cohan's new 670-page blockbuster Money and Power, How Goldman Sachs Came to Rule the World, his third Wall Street "history" in just three years.

by Roy C. Smith

Charles D Ellis spent 10 years writing The Partnership, his much praised 2008 effort to capture the "culture" of Goldman Sachs, and so Cohan's latest effort seems a rush job to catch the last of the lingering public rage against the big banks that played so rough during the financial crisis.

Cohan interviewed former senior partners, who turned out to be much more loquacious than expected for a firm known for its secretive ways.

The glitzy New York version in Vanity Fair included a lengthy, pre-publication excerpt covering 1989-1999 when the firm had five chief executives. This was truly a messy period in the firm's history, full of juicy bits for gossips to savour.

But the piece never mentioned that these were very difficult times in both Wall Street and the City of London, when firms changed their business models drastically to survive and a great many distinguished names either failed or disappeared into mistaken or unwanted mergers.

Goldman is one firm that sailed through this period, despite its management changes and other tumultuous events, without slowing down much at all. Indeed, it emerged after its initial public offering in 1999 as the unquestioned leader of the global capital markets industry.

read the full opinion-editorial on efinancialnews.com

No need to fear the shadows

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by Roy C. Smith

With the big banks under the boot of the regulators, tucked up with tougher capital ratios, trading restrictions and deferred incentives to rein in recklessness, some bank chief executives and academics have called for similar restrictions on the "non-bank monsters" of the shadow banking system where dangerous, unregulated risks are said still to reside.

A shadow banker is anyone who participates in the lending of money or its near equivalent. These would include financial intermediaries, off-balance-sheet investment vehicles and hedge funds, as well as institutional asset managers.

Altogether, global institutional investors managed about $150 trillion of securities and derivatives in 2009, compared with about $95 trillion for all banks.

But the idea that the next meltdown will occur in the widely distributed shadow banking sector is nonsense, now that its riskier aspects have been addressed.

The five systemically important US non-bank intermediaries - investment banks - were dissolved by the crisis: Lehman Brothers failed, large banks acquired Bear Stearns and Merrill Lynch, and Morgan Stanley and Goldman Sachs turned themselves into banks. The Federal Reserve now regulates them all.

Read the full opinion editorial on eFinancialNews.com.

by Jennifer Carpenter and Ingo Walter

Nothing about the financial crisis has done more to outrage the public and fuel reform than the drumbeat of bankers' pay announcements. Pay levels at Wall Street's top 25 banks reached a record high of $135bn last year, with employees' share of revenue rising to 32.5 per cent. While shareholders may have reason to object, the real concern for regulators and taxpayers on the hook for the next bail-out is not the level of pay, or how profits are divided between employees and shareholders, but rather the risk incentives that bank pay creates.

Reports of increased use of deferred compensation are cold comfort if it is in the form of stock, because as long as government guarantees are underpriced, the value of the stock increases with the bank's risk and leverage, so employees and shareholders are aligned in their incentives to ramp up risk. The Securities and Exchange Commission has just proposed to curb risk appetite by regulating bankers' compensation directly, requiring top executives at large banks to defer at least 50 per cent of incentive pay for three years. Regulators would do better to tackle the problem at its source, by setting deposit insurance premiums and taxes on other financial groups commensurate with the level of systemic risk they generate, and taking the risk appetite out of the equity itself.

Read the full opinion editorial in the Financial Times


Volcker May Get the Last Laugh

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by Roy C. Smith

The Dodd-Frank regulatory reform act in the US gives banks plenty of time to adjust to its Volcker Rule, the disallowance of proprietary trading.

The law itself provides them with lots of wiggle-room, with implementation left to the , which recently released a study it was required to make about the new rules.

Next, the FSOC will have to finalise the rules (expected in June) and circulate them for discussion and push-back from lobbyists. Then there will be a lengthy period allowed for the banks to put them into effect. It could all take years.

The FSOC study acknowledges that the distinction between "permissible" and "impermissible" trading may be difficult to make. Market-making, for example, is allowed under Dodd-Frank. This is defined by the banks as trading with or on behalf of clients.

The banks say there is no proprietary trading if any position held was acquired assisting a client. Also, virtually all trading today is financed in the market, through the repo or secured loan markets, so prop trading is hard to identify simply as being financed by a firm's own money.

Read the full opinion editorial on eFinancialNews.com.


Reshuffling the Banking Pack

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by Roy C. Smith

As hated as they are, bailouts, until recently, were accepted as being a necessary evil: a safety net to preserve the financial system after regulatory measures fail. But bailouts today are deeply resented, despite the fact that they usually work to stop panics, and are much cheaper than letting everything go up in smoke. Recently the Fed admitted that it alone deployed $3.3 trillion to stabilize massively disrupted credit markets after the bankruptcy of un-bailed out Lehman Bros.

Banks are now told that the era of too-big-to-fail is over. The Dodd-Frank Act has forbidden bailouts, and will subject systemically important banks to "enhanced" regulation to prevent failure. Governments generally have loaded these banks with new taxes, fees and other expenses to recover taxpayer losses. Together with higher capital requirements of Basel III and a variety of regulations yet to be written, the composite new regulatory package hopes to suppress big banks' appetites for risk.

But, having removed the safety net, what the government needs is a fail-safe financial system. So far they haven't achieved it.

Read the full opinion editorial on eFinancialNews.com.

by Viral V. Acharya 

Slightly over two years since the collapse of Lehman Brothers, the financial sector reforms in developed economies are still evolving. One definitive piece of legislation has been the Dodd-Frank Act, passed earlier this year by the US Congress, to restore US financial stability. How effective would the Act's provisions have been, starting in 2003-2004 (years during which the housing credit boom took hold) and until the fall of 2008 (when the financial system had to be rescued)? Would the Act have prevented the enormous build-up of leverage on financial balance sheets all betting against a material correction in the US housing market?

Read the full opinion editorial on Livemint.com.
Regulating Wall Street Co-Editor Viral Acharya is interviewed by Mint on regulatory reforms and the policy challenges India faces, from the sidelines of the Emerging Markets Finance conference organized by the Indira Gandhi Institute of Development Research (IGIDR) in Mumbai. 

Watch the interview on LiveMint.com

Lower Capital Tax Rates Permanently

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Regulating Wall Street Co-Editor Thomas Cooley appeared on the FOX Business channel, arguing that lowering tax rates permanently on capital income would promote economic growth.

Watch Professor Cooley's interview on FOXBusiness.com.

The Bush Tax Cuts Never Went Far Enough

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by Thomas F. Cooley and Lee E. Ohanian 

The Obama administration has announced its willingness to compromise on a temporary extension of the Bush tax cuts for all income levels. But the Bush tax cuts never went far enough in providing sufficient incentives to promote higher rates of savings and investment. Temporary solutions like this one or the administration's proposed investment tax credit for businesses will not solve our problem of low capital accumulation. What matters is how the income from capital is taxed over its lifetime.

Economists agree that a large capital stock is a key ingredient for prosperity, as it expands our productive capacity and raises worker productivity, which in turn increases wages and consumer purchasing power. Our capital stock is comparatively much smaller today than it was before the Great Depression. The ratio of business-sector capital to output is about 30% smaller today than it was in 1929. This shortfall reflects the fact that recent investment rates have been lower and consumption rates have been higher compared to earlier in our history.

Read the full opinion editorial on WSJ.com

by Matthew Richardson

I am all for free markets and not mucking them up with government intervention. But the economic theory of regulation tells us that if there is a market failure, it cannot be resolved privately. The public sector must get involved.

The most illustrative examples of such failures in U.S. financial markets were the frequent financial panics from the 1850s until the Great Depression. Those episodes taught us that when illiquid, asset holdings (e.g., loans) of the financial sector are financed short-term (e.g., by deposits), and are hit by a severe macroeconomic downturn, failures of financial firms can lead to system-wide runs on deposits. This in turn leads to a massive disruption of the system that provides credit to households and corporations. When economists bandy about the term systemic risk, this is the type of event they are referring to.

The market failure here is that, although each financial institution may have been behaving optimally on an individual basis, the firm had no incentive to take into account the effect of their actions on the system as a whole. In economics, we call this a negative externality and it is analogous to an industrial firm causing pollution. In the example above, financial failure of one bank increased the possibility of runs on other banks, leading to the system-wide collapse.

Read the full opinion editorial on Big Think.com.

About RegulatingWallStreet.com

The Dodd-Frank Act, signed into law in July 2010, represented the most significant and controversial overhaul of the U.S. financial regulatory system since the Great Depression. Forty NYU Stern faculty, including editors Viral V. Acharya, Thomas F. Cooley, Matthew P. Richardson, and Ingo Walter, provide a definitive analysis of the Act, expose key flaws and propose solutions to inform the rules’ adoption by regulators, in a new book, Regulating Wall Street: The Dodd-Frank Act and the New Architecture of Global Finance (Wiley, November 2010).

About Restoring Financial Stability

Previously, many of these faculty developed 18 independent policy papers offering market-focused solutions to the financial crisis, which were published in a book, Restoring Financial Stability: How to Repair a Failed System (Wiley, March 2009).

About the Authors