Wednesday, January 27, 2010

Regulating banks

1. New financial products are like new drugs and should be treated as such. New financial products have to undergo "trials" and data collected extensively before being offered to the general public.

Unlike new drugs, financial products need only be safe and not necessarily effective.

2. MR comments on the Volcker banking plan that regulates bank size and limits proprietary trading. As has been mentioned previously here, and here that limits on bank size is in effect a limit on profits. Perhaps the best way to go is to treat all financial institutions as public service companies such as water companies. Hearings are held as to whether new products can be launched, how much pay top management should receive and how much products should be charged. (No, seriously!)

The public service commission approach will answer most (if not all but #7) in a positive manner:

1. Do its restrictions apply to subsidaries, affiliates, and holding companies in a meaningful way? Can they apply?

2. How do the restrictions apply to off-balance sheet activities, if at all? Keep in mind the various lessons about the construction of synthetic asset positions.

3. How will Congressional oversight committees apply and interpret the plan? This is a big one.

4. Can a financial institution avoid or sidestep the restrictions by changing its status as a commercial bank, legally speaking?

5. If you cap bank size, are the new and smaller banks still "too big to fail" by prevailing standards?

6. How does the proposal treat bank leverage, including implicit forms of leverage through off-balance sheet activities? Does leverage get redistributed elsewhere?

7. How does it affect the political economy of bank lobbying?


The above most thoughtful questions are from MR.

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