Four Intriguing Ideas for How to Fix the Banks

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A lot of people have the sneaking suspicion that the 2008-09 financial crisis could repeat itself because reform efforts—such as the Dodd-Frank Act—haven’t gone far enough. But they’re not sure what to do about that.

Enter Americans for Financial Reform and the Roosevelt Institute with some proposed solutions that are bound to be unpopular with the big banks and their shareholders. Today those organizations gave reporters an early look at papers that will be presented at a Nov. 12 conference in Washington, “An Unfinished Mission: Making Wall Street Work for Us.”

“Right now is a really interesting time to be talking about a lot of this,” Mike Konczal, a fellow at the Roosevelt Institute who is contributing a paper, said in an interview. “You see a lot of people reaching for ideas, and hopefully this will set an agenda.”

You get a sense of where the organizations are coming from when you see whom they’ve chosen as their keynote speaker: Senator Elizabeth Warren, the Massachusetts Democrat who has sparred with such bankers as Jamie Dimon and spearheaded the creation of the Consumer Financial Protection Bureau.

Here’s the quick takeaway from four of the papers:

• Higher and smarter capital requirements would hit six birds with one stone, writes Konczal. Capital is the cushion of money that keeps a bank from going bust when it loses money, harming depositors and taxpayers. Konczal says more capital would make firms less likely to fail, simplify risk management, make ending too-big-to-fail more credible, help bring order to shadow banking, force large banks to pay a price for their size and complexity, and enable the Federal Reserve to smooth out booms and busts.

It’s that sixth bird, involving the Fed, that’s most interesting. The capital requirements we have now can inadvertently exacerbate the business cycle: When times are good, banks have plenty of regulatory capital, so they’re tempted to overlend; when times are bad and capital shrinks, banks have less capital and cut back lending, making matters worse. Raising and lowering capital ratios the way a hot-air balloonist adjusts the temperature might smooth out the business cycle. Writes Konczal: “It may be that the Federal Reserve, instead of just announcing a single interest rate, also announces several other metrics that it uses to ensure full employment and price stability—something like the ratio on bank capitalization.”

• Banks need to be stopped from turning into “financial-industrial conglomerates,” writes Saule Omarova, a professor at the University of North Carolina School of Law who has criticized big banks’ involvement in markets for such commodities as aluminum. Omarova writes that financial holding companies “may also be acquiring stakes in airports, railroads, telecommunications, or defense companies, we simply don’t know.”

• The Dodd-Frank Act’s provisions for failing banks is full of holes, writes Stephen Lubben, a Seton Hall Law School professor. Insolvent banks are supposed to go through bankruptcy court just like nonfinancial companies, except in unusual circumstances, but bankruptcy procedures that can handle banks haven’t been developed, Lubben says. And the supposedly rare alternative, which involves giving “orderly liquidation authority” to the FDIC, “quickly could become a stealth bailout of subsidiary creditors.”

• It was a huge mistake for Congress to allow swap contracts to be unregulated, writes John Parsons, a professor at the Massachusetts Institute of Technology’s Sloan School of Management. Credit default swaps written by AIG’s Financial Products unit went so bad that the U.S. had to take over AIG, the world’s biggest insurance company. Parsons says regulation is heading in the right direction, but slowly. “The key elements of reform—universal supervision, transparency through exchange-trading and price reporting, and central clearing—are tools for reclaiming the powerful good these financial instruments can provide,” he writes. “There remains much to be done to realize that goal.”

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