Please! No More Kabuki Finance Reform!

Today’s Wall Street Journal highlights the Details Set for Remake Of Financial Regulations. The question on every one’s kabukimind is will it be real this time instead of some show that shuts down the minute the press leaves the room. (You know when Barny Frank and Chris Dodd trot out the single malt and the Cuban Cigars and party down to Chain, Chain, Chain … chain of Fools.

President Barack Obama is expected Wednesday to propose the most sweeping reorganization of financial-market supervision since the 1930s, a revamp that would touch almost every corner of banking from how mortgages are underwritten to the way exotic financial instruments are traded.

We shall see, we shall see. In today’s WAPO, Timothy Geithner and Lawrence Summers are inkling their strategy in A New Financial Foundation. They identify five key problems in the article they see with the current regulation regime.

First, existing regulation focuses on the safety and soundness of individual institutions but not the stability of the system as a whole. As a result, institutions were not required to maintain sufficient capital or liquidity to keep them safe in times of system-wide stress. In a world in which the troubles of a few large firms can put the entire system at risk, that approach is insufficient.

Capital requirements are always nice in a fractional reserve system. After all, banks only make money by lending out the funds they hold at a higher rate, but this needs to be closely examined; especially with capital from government sources at the risk or implied government guarantee of assets. I talked before about Stiglitz’s concept of Banks Too Big to be Restructured. Many of us feel that these banks don’t need to be better regulatedbut completely busted up. The joint statement appears to say that the Obama Adminstration is prepared to let them dither in Zombie land while making them come up with more capital. (The only thing I can say is how long and with whose money?) I call this passage a stinker, but I’ll wait to see the details in the bill itself. If they regulate it the way they regulated Fannie and Freddie, hide your savings under your nearest mattress and try to get all your income in Eurodollars.

The administration’s proposal will address that problem by raising capital and liquidity requirements for all institutions, with more stringent requirements for the largest and most interconnected firms. In addition, all large, interconnected firms whose failure could threaten the stability of the system will be subject to consolidated supervision by the Federal Reserve, and we will establish a council of regulators with broader coordinating responsibility across the financial system.

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