Banking on Change (Part 3)

I’ll break banking reform down into two parts: what should be, and what will be.

What should happen in finance is a massive simplification that deals with “too important to fail” and provides funds for all kinds of companies that need cash through their product cycle. This should be coordinated internationally, because the cross-border issues are often what makes finance so complex.

As the banks get bigger they should have to set aside more and more capital, making larger institutions more resilient. This would create diseconomies of scale that would make excessive size increasingly costly, lessening systemic risk. Because capital is expensive, the market would discipline companies that carelessly grow too big.

This could be tied to a leverage fee. Lower capital levels could trigger higher fees. And a resolution authority to shut down undercapitalized banks should be in place. Unlike the FDIC, this should not include debtor protection. Instead, a clear scheme for bankruptcy reorganization should be enacted that includes haircuts for creditors, just as Chapter 7 and Chapter 11 do.

Finally, the Federal Reserve needs to be reexamined. I’m grateful that they kept our economy from falling into another Great Depression, but just because they missed the last two bubbles doesn’t mean they should be given more power to miss the next one.

This is what reform should include: market-based mechanisms to protect the bankers from themselves. What we will get will be another thing entirely.

Douglas R. Tengdin, CFA
Chief Investment Officer
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