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Huntsman Financial Reform Proposal

Huntsman Financial Reform Proposal

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Published by: Michael Brendan Dougherty on Nov 28, 2011
Copyright:Attribution Non-commercial


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Financial Regulatory Reform
As President, Governor Huntsman will make financial regulatory reform a high priority. Real financialreform will mean breaking the Faustian bargain between Wall Street and Washington that helped fuel thehousing bubble, drove a series of bailouts, and prevented meaningful reform in the aftermath of thefinancial crisis.More specifically, real reform means repealing the 2010 Dodd-Frank law, which perpetuates too big toofail and imposes costly and mostly useless regulations, on innocent smaller banks without addressing theroot causes of the crisis or anticipateing future crises. But the overregulation cannot be addressed politically without ending the bailout subsidies, so that is where reform must begin.The world’s financial system is going through a major shake-up – with large parts of it falling into statehands, for example in Europe. To remain competitive, America must think differently. We need to startthinking prospectively about an evolving and complex financial system. But this cannot mean that thegovernment allocates credit. We need the market to allocate credit, without the kinds of subsidies thatencourage a build-up in dangerous amounts of borrowing and leverage anywhere in the economy.
Today we can already begin to see the outlines of the next financial crisis and bailouts. More than threeyears after the crisis and the accompanying bailouts, the six largest U.S. financial institutions aresignificantly bigger than they were before the crisis, having been encouraged by regulators to snap upBear Stearns and other competitors at bargain prices. These banks now have assets worth over 66 percent of gross domestic product—at least $9.4 trillion, up from 20 percent of GDP in the 1990s.There is no evidence that institutions of this size add sufficient value to offset the systemic risks they pose. In fact, the megamergers that prompted the repeal of Glass-Steagall have failed to provide the benefits that were promised to America’s consumers; the average checking-account holder pays nearlytriple what banks charged two decades ago.The major banks’ too-big-to-fail status gives them a comparative advantage in borrowing over their competitors, thanks to the implicit federal bailout backstop. This funding subsidy amounts to at least 25 basis points and perhaps as much as 50 basis points, or between one-quarter and one-half of a percentage point. In today’s markets, this is a huge advantage.Governor Huntsman believes we must build resilience into the financial system by getting ahead of thenext financial shock. Anything that is too big to fail is simply just too big – with the real danger thatlarge banks have the incentive and ability to become even bigger. Next time, the largest banks may beso big that their failure will swamp the fiscal balance sheet of the government. If we let today’sfinancial behemoths grow unchecked, this will lead to fiscal ruin.There are a number of tools we can use to break the “doom loop,” in which banks and their creditors are bailed out, and therefore feel empowered to again take excessive risk. As President, Governor Huntsman will work with Congress to implement one or more of the following:
Set a hard cap on bank size based on assets as a percentage of GDP. (This cap would be on total bank size, not using any of the illusory “risk-weights” currently central to thinking about bank accounting. The lowest risk assets for banks in Europe, supposedly, are sovereign debt—yet this
very same debt is now at the heart of the current crisis.) 
We should have a similar cap on leverage—total borrowing—by any individual bank, relative toGDP. In some European countries, one bank can bring down the nation. Why would we wantsuch unfair and inefficient arrangements in America? 
Explore reforms now being considered by the U.K. to make the unwinding of its biggest banksless risky for the broader economy.
Impose a fee on banks whose size exceeds a certain percentage of GDP to cover the cost theywould impose on taxpayers in a bailout, thus eliminating the implicit subsidy of their too-big-to-fail status. The fee would incentivize the major banks to slim themselves down; failure to do sowould result in increasing the fee until the banks are systemically safe. Any fees collected would be used to reduce taxes for the broader non-financial corporate sector.
In addition, focus on establishing an FDIC insurance premium that better reflects the riskiness of  banks’ portfolios. This would provide an incentive for banks to scale down, allowing the financialsystem to absorb them organically in the event of a collapse.
Strengthen capital requirements, moving far beyond what is envisioned in the current BaselAccord. The Accord is a mixture of regulatory oversight and political compromise. As a result,the U.S. has allowed its banking policy to be determined by the “least common denominator”among European and Asian countries, many with a long history of not being prudent. We want afinancial system that has more equity financing and relatively little debt financing. Eliminating subsidies would encourage the affected institutions to downsize by selling off certainoperations or face having to pay the real costs of bailouts. Removing the taxpayer subsidies that createtoo big to fail will also strengthen local and community banks who are unable to compete with thesubsidized megabanks.We need banks that are small and simple enough to fail, not financial public utilities. Hedge funds and private equity funds go out of business all the time when they make big mistakes, to the notice of few, because they are not too big to fail. There is no reason why banks cannot live with the same reality.This country was not built on the basis of big banks. The dynamism of our core non-financial sector does not depend on having financial institutions that can take—and consistently get wrong—economy— sized risks.
As President, Governor Huntsman’s administration will be committed to enhancing transparency in thederivatives markets. An opaque derivatives market was one reason for the systemic impact of thesubprime mortgage crisis. Greater transparency will permit greater oversight by both market participantsand regulators—and will also allow end-users to negotiate better terms with Wall Street and, in turn,lower trading costs. We need to encourage the creation of multiple clearinghouses in order to minimizethe systemic impact of a problem in any one of them.
Derivatives should include uniform minimum collateral requirements – that is, limits on potential borrowing -- from the onset of their trades; such margin requirements would incentivize prudent risk management internally and build up resilience to losses. Commodity derivatives traded on the ChicagoBoard of Trade are already subject to such measures.
Governor Huntsman believes that Dodd-Frank was an inappropriate regulatory response to the Panic of 2008. The legislation signed into law by President Obama in summer 2010, ignored the government’s pervasive role in causing the crisis, assures future transfers from taxpayers to bankers by institutionalizinga government backstop for too-big-to-fail firms, and imposes massive new regulations and unreasonablecompliance costs on smaller financial firms. As a result, lending to small businesses from small bankshas suffered.There is no better example of the perverse incentives of Dodd-Frank than Bank of America’s decision thisfall, when faced with a credit downgrade, to move part of its derivatives book from Merrill Lynch toanother subsidiary that was covered by FDIC insurance. The move was possible only with the agreementof the FDIC, the Federal Reserve and the Treasury Department.Once too-big-to-fail is ended, and we have implemented real derivatives reform, Governor Huntsman believes that Dodd-Frank should be repealed. Its replacement should follow two principles: Failure is the best form of risk management, and maximizing transparency leads to more efficient and fairer financialmarkets.
Governor Huntsman will end Wall Street’s reliance on short-term leverage to fund long-term holdings.The mismatch in maturities was at the core of much of the Panic of 2008, and it cannot be sustained. AsPresident, Governor Huntsman will also implement tax reform that includes eliminating the deduction for interest payments that gives a preference to debt over equity, thus ending subsidies for excess leverage.The overall corporate tax burden will fall, as part of these reforms – this is good for the nonfinancialsector and good for well-run smaller financial firms. But the subsidies to large, highly-leveraged financialfirms will also be eliminated. The US government should not encourage excessive risk-taking by big banks—this is absolutely not in the interest of anyone else in the economy.
Governor Huntsman believes that risk needs to be acknowledged and managed properly. The Basel IIIAccord primes the pump for the next financial crisis by putting its thumb on the scale of sovereign debt,making it less expensive for banks to invest in those instruments without making a realistic risk assessment.Going forward, financial institutions must incorporate realistic assessments of credit risk for allinvestment assets, including sovereign debt; those assessments should not be limited to the Eurozonemember states, but extend to for all states whose debt carries potential risk.Banks will make these assessments not because a regulator or government official tells them what are theappropriate risks, but rather because—if they don’t get it right—they will face the risk of real failure.

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