Reach equals grasp on banking bill
- A supporter of financial reform legislation demonstrates on Capitol Hill. AP Photo
As long as there are the megabanks that are too big to fail, government will, more likely than not, “blink” again. Too-big-to-fail institutions have an incentive to engage in excessive risk-taking: Heads they win; tails taxpayers lose.
They also have a competitive advantage not based on greater efficiency but on the implicit subsidy of a future government bailout. Thus, every provision that levels the playing field — imposing additional restrictions on risk-taking, setting higher capital requirements or imposing additional fees — needs to be retained.
Distorted incentives that encourage excessive risk-taking and shortsighted behavior were, of course, endemic throughout our financial system.
Banks need incentives to improve incentives, but given well-known problems in corporate governance, that is not enough: The distorted incentive structures should be proscribed.
Because this is unlikely to be done effectively, it is essential to curb the risk-taking directly.
Many of today’s problems are a result of repealing the Glass-Steagall Act. This led to conflicts of interest (for example, the Enron and WorldCom scandals); increased concentration in the financial sector; and the spread of the investment banks’ culture of risk-taking to commercial banks, our basic means of payment.
No compelling case has been made that repeal led to economies of scope or scale. In fact, the crisis offered compelling evidence that it caused only large risks to our economy and to taxpayers.
A 21st-century financial system needs a new set of restrictions to reduce both these risks and the risks of conflicts of interest. That is why it is essential that the “Volcker rule” and the restrictions on excessive risk-taking and conflicts of interest be as strong as possible.
Derivatives also played a major role in this crisis and are likely to play an even larger role in the next, unless we do something.
That is why it is imperative that Section 716 of the Senate bill be retained. It protects both taxpayers and investors by imposing a fiduciary duty on swap dealers; combating fraud; and reducing the scope for manipulation and insider trading.
It also closes the key loophole on foreign exchange swaps. The exemptions from trading on exchanges and through clearinghouses need to be curtailed. The “discouragement” of over-the-counter products needs to be more than words — they alone won’t do the trick.
There is still a gaping loophole in enforcement. Because of a “technical adjustment,” under the current bills, if a swap has not been properly cleared and exchange-traded, regulators have no clear legal authority to undo an unlawful deal.
Instead, the bills say that a deal cannot be undone for failure to comply with the clearinghouse and exchange-trading requirements! Sen. Maria Cantwell (D-Wash.) has championed a “fix,” which has received bipartisan support. The final bill must have effective enforcement.
There is a legitimate debate about whether certain derivatives should be viewed as insurance or gambling instruments. But in either case we should regulate them, and we should not encourage or subsidize them — as we do today.