Tuesday, April 13, 2010

Spitzer and Bank Regulation

Among politicians (or ex-politicians in this case), Eliot Spitzer is quite perceptive about financial regulation. He has been writing pieces for Slate, the most recent of which is this one. It's too bad that his own risky behavior ruined his political career, but maybe he can redeem himself - stranger things have happened. Generally, Spitzer makes a good case that the Financial Crisis Inquiry Commission is not doing its job. The key passage in his piece is this:
During the pallid congressional debate over reform, Washington has utterly abandoned the structural reform that we actually need. There is an international consensus that banks are too big and the concentration within the banking sector is increasing, not decreasing. Fundamental reform will not come from having a few regulators "oversee" the sector. Reform will come from breaking apart the overly concentrated banks and separating them. The banks need to be broken up as AT&T and Standard Oil were busted, in order to stimulate competition and creativity.

Perhaps it's not too late for Congress to consider adding these three simple rules to its reform bill:

-Banks receiving taxpayer guarantees cannot engage in any nonbanking activity. Institutions must choose: Either you can have public guarantees or you assume risk through investment banking and proprietary trading, but you can't have both.

-Increase capital requirements to no less than 15 percent, and require on-balance-sheet disclosure of all material information pertaining to liabilities of the entity.

-require that banks pay penalties, dilute equity, eliminate management options, and repay executive bonuses before receiving any taxpayer bailout.

As I commented in an earlier post, it is certainly true that concentration in the banking industry is increasing, but I attribute that more to scale economies than the implicit subsidy from too-big-to-fail (though I think the latter is significant). I also disagree with Spitzer's notion that a key element of reform is breaking up the big banks. As I've said in other posts, I think we should embrace large banks and reform the regulators. I think Spitzer's three simple rules are good ones, though. In the case of the third, though, with appropriate regulation there should be no "bailouts" as we know them.

The regulatory reform which we should have (and have zero probability of getting) would be an elimination of overlapping and competing regulatory authorities, with one regulatory institution given the authority for supervising banks.

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