At a hearing of the House Financial Services Committee yesterday, Barney Frank nicely summarized where we are with regard to re-regulation of our largest financial institutions: some of them are definitely “too big to fail”, with the potential to present the authorities with what Larry Summers calls the “collapse or bailout” choice, but what exactly should be done about it?
On a five-person panel, I had the middle seat (as usual) and found myself agreeing with points made both to my left and to my right. Alice Rivlin is correct that we need to control leverage as well as increase capital requirements, and the Fed’s tools vis-à-vis leverage need modernization – your grandparents’ margin requirements would not suffice. Peter Wallison, a member of the new financial crisis investigation commission, stresses that capital requirements should be higher for larger banks. Paul Mahoney wants to change the bankruptcy code, to make it easier for courts to handle large financial firms in quick time; recent CIT Group events suggest this is a good idea.
And Mark Zandi was persuasive on the point that households had no idea what they were signing up to with option ARMs – even he has trouble with those spreadsheets. Effective consumer protection – including a new consumer safety commission – would definitely contribute to financial system stability.
What will Barney Frank and his committee do? There will be no “Tier 1 Holding Company” category of firms, if Frank has anything to do with it; this is too much like creating an implicit government guarantee. Frank is clearly drawn towards higher capital requirements or more insurance payments from firms that pose more system risk. I suggested total assets of 1% of GDP as a threshold, but we agree this should be essentially a progressive drag on profits – creating the strong market-based incentive for the biggest firms to downsize.
Other than that, watch this space.
My written testimony submitted to the committee is below. Continue reading