The options for financial reform.Michael W. Brandl, PhDThe University of Texas at AustinMcCombs School of BusinessMarch 19, 2010

The need for reform The “Great Recession” that started in 2007

was trigger by a global financial crisis. Clearly there need to be structural reforms of our financial

system. The business press seems more interested in the “politics”

of financial market reform than the key issues. What is a manager to do? Where to turn for information?

We will examine: Basic ideas: Tobin Tax & The Volcker Rule Restructuring ideas: LPB, John Taylor, The Basel Group,

Simon Johnson, Niall Ferguson, and Lord Turner.

You decide…

The Tobin Tax The idea – James Tobin originally suggested in

1972 a tax “of about 0.5%” on FX transactions. 2010 version: Sarkozy of France, Brown of the

UK are suggesting a global Tobin tax on all financial transactions. Those in favor: the tax would: a) raise tax revenue to payfor past bailouts, b) increase cost of speculative trading, c) bea sales tax on financial markets.

Those against: the tax would: a) be passed onto “Main Street”, b) force a massive sell off of stocks, c) tax those that did not speculate.

Most likely outcome: European Parliament is pushing G20 to adopt it in June 2010 meetings.

The Volcker Rule The idea – forbid institutions that have access to

the Fed facilities from undertaking proprietary trading.

2010 version: President Obama named it after Paul Volker. Those in favor: creates a wall between those entities

involved in the payment system and those who want to take on more risk.

Those against: difficult to determine what is “proprietary” trading; unclear what role this played in the current crisis; banks will find ways around it.

Most likely outcome: it’s likely dead. Dodd said “it should be studied…”

Limited Purpose Banking The Idea: banks and insurance companies

would become mutual funds. They would not be allowed to borrow to invest. All transactions are settled through a Federal Financial Authority. Those in favor: individuals take on risk not the

institutions. Larry Kotlikoff (BU) & Ed Leamer (UCLA)No need for FDIC insurance – cash mutual funds to insurance mutual funds.

Those against: LPB ignores what depository institutions do: a) maturity transformation, b) disability and c) solve asymmetric information problem…what about consumers – will they be able to understand the choices?

Most likely outcome: slim to none…no one in Washington is discussing it.

John Taylor Stanford economist (Taylor Rule of monetary policy)

Idea: need a database on the interconnections of the financial markets – who is lending to whom?

Need simple rules/law based process for liquidation (Chapter 11F) not another regulator.

Those in favor: Gov’t ad hoc bailouts & lack of transparency created uncertainty and crisis.

Those against: Who is going to enforcethis? Fed got us into this messand can’t be relied upon to protectconsumers – they only worry aboutthe financial industry.

The Basel Group Collection of international bank regulators Suggests government need contingency

plans for failures of specific banks & insurance plans. “Living wills” will be required for all systemic institutions.

Governments should co-ordinate national rules and share information. Those in favor: forward looking & global in focus. Those against: regulators may be reluctant to use the

“living wills” due to political pressure and thus we would be back to tax-payer bailouts and uncertainty.

Most likely outcome: keep on eye on this…it’s likely.

Simon Johnson MIT Sloan economist & author

“The Quiet Coup” The Atlantic May 2009

The Idea – bankers & fin mkts have far too much political and social power “intellectual capture.”

2010 version: break up big banks,regulation since Reagan has gone wrong, replace TBTF with “small enough to fail.” Those in favor: historical proof of ongoing political and social battle.

Those against: size of the institutions is notWhat matters, it is management and regulation.

Niall Ferguson Reforms The idea – most suggested reforms are little

more than window dressing. Excessive leverage, toxic assets, reckless insurance of risk, excess incentives for homeownership and China’s FX policies are the causes.

Suggestions: Flat tax of 25%, VAT 7.5-10% and lower corporate tax. Tax spending not income. Those in favor: sound structural reforms

Those against: Krugman & DeLong - doesn’t address Wall St bonuses;doesn’t understand the importanceof consumption spending.

Lord Adair Turner Chair of British Financial Services Authority

Britain's top bank regulator Called recent financial innovations “socially and

economically useless.” Quoted Keynes’ “fetish of liquidity” 2010 version: Tobin tax, higher capital requirements, max

loan/value ratios and Macro-prudent committee – 2 yr review

Those in favor: structured financial products do not need liquidity as do fx mkts

Those against: too many regulators already; Tobin tax is unworkable; need to break-upBig institutions (Tories)

Where we are now… Senate Banking Committee will debate

Dodd’s “proposal”: New Consumer Financial Protection Bureau in the Fed Financial Stability Council: A systemic risk regulator made

up of Treasury, Fed, SEC, FDIC, CFPB, etc. Resolution Authority: Council of regulators headed by

FDIC would work out resolutions of TBTFs. Securitizers would have to maintain 10% of risk (House bill

is 5%) Bank employees past/present can not be Fed directors No leverage limit (House version cap 15:1) Small banks (under $50m) regulated by FDIC not Fed

Not much difference btw Dodd and House version…

Q&A

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