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Sid Salvi, Ilana Fischer, Alison Flint, Thu Nguyen, and Matthew Brewster Lucas Puente Editor
2 5 7 Executive Summary Introduction Systemic Risk Oversight Recommendations based on Millennial Generation Priorities The House The Senate Alternative Perspectives Curbing “Too Big to Fail” Recommendations based on Millennial Generation Priorities The House The Senate Alternative Proposals Financial Transactions Tax Recommendations based on Millennial Generation Priorities The House The Senate Consumer Financial Protection Agency Recommendations based on Millennial Generation Priorities The House The Senate Reforming the Federal Reserve Recommendations based on Millennial Generation Priorities The House The Senate Additional References
The five issues outlined below are of utmost importance to Millennials given their immediate implications for our financial well-being and their impact on our nation’s long-term economic sustainability. Millennials having been more adversely affected than any other age bracket, with youth unemployment hitting 18.5 percent in July 2009, the highest July rate since 1948.1 Seniors graduating from college or high school can attest to the great difficulty of finding employment. Additionally, low-income and middle-income college students have faced great challenges paying for their education. Acknowledging this, substantive reform is absolutely compulsory. Our generation has witnessed the current economic downturn in some of our most formative years and we have been disproportionately affected. This report, which identifies the most important priorities for young people in regards to financial regulatory reform, seeks to inform young people about the issue, the best solutions, and why we need to step up and ensure something happens now. Summary of Recommendations • Create a Systemic Risk Regulatory Authority with resolution authority that seeks to inform the financial industry of key risks and incentives. • Build a registry of “Too Big to Fail” companies who will face a tax based on their level of systemically risky business. • Enact a Financial Transactions Tax and Insurance Fee, and thus limiting the flow of “hot money” that offers little in the way of sustained economic investment. • Protecting consumers from deceptive lending and predatory financial products by enacting the Consumer Financial Protection Agency, • Reforming the Federal Reserve through increased transparency and stripping it of certain responsibilities that are better absorbed by an independent financial regulator. Systemic Risk Oversight Regulators have failed to reign in systemic risk, thereby implicitly enabling the financial crisis. This is a key component to the current situation young people find themselves in, where jobs and credit are increasingly scarce. As a result, the authors of this report are strongly in favor of the creation of a consolidated Systemic Risk Regulatory (SRR) agency, which by stabilizing the financial system would greatly lessen the threat of future recession of this size and its associated consequences, such as high unemployment, as well as ensure that all people – especially Millennials - have access to credit (and thus allowing them to become first-time home-buyers, receive low-interest loans to college, etc.) This entity would be best served to have resolution authority that, among its regular duties, will offer consistent reports on risks to the financial system, incentives to motivate compensation for long–term performance, and stricter disclosure requirements for over-the-counter derivatives (which are securities that derive their value from another financial instrument like stocks or bonds). The bill crafted by Congressman Barney Frank and passed by the House in December calls for the establishment of a council of regulators that would oversee all banks and systemically important insurers. This entity, to be called the Financial Services Oversight Council, would be charged with monitoring macrolevel activity and periodically intervening in the financial services industry. The bill currently being crafted by Senator Dodd calls for the creation of an entity with very similar powers to the House’s Financial Services Oversight Council. However, this entity would be an entirely new agency - tentatively named the Financial Stability Agency - with a board comprised of current regulators.
1. Bureau of Labor Statistics, July 2009, http://www.bls.gov/opub/ted/2009/ted_20090828.htm 2
Curbing Too Big To Fail The issue of “too big to fail” in banking is naturally quite significant to Millennials given its potential effect on our long-term economy. Choosing to not address the phenomenon of “too big to fail” would only exacerbate this issue by letting the biggest banks grow more powerful, both economically and politically. Thus policy makers must implement a mandatory registry of large, systemically important institutions, including hedge funds, and make these firms pay a fee to compensate for the tacit protection they are given by the government In addition, they should face increased capital and liquidity requirements, which would be scaled to firm size. In addition to the duties listed above, the House’s proposed Financial Services Oversight Council would also have the extraordinary ability to wind down Systemically Important Financial Institutions (SIFI). Simultaneously, the bill would expand the powers of the Federal Deposit Insurance Corporation (FDIC), by empowering that body to unwind insolvent financial firms. To this end, a “systemic dissolution fund” would be established through fees imposed on big banks. Meanwhile, the Senate bill would create a Financial Stability Agency and grant this body the authority to force SIFIs to divest their holdings and generally downsize, thereby reducing these companies’ systemically risky financial services activity. That bill in its current form would also abolish the Office of Thrift Supervision and the Office of the Comptroller of the Currency as well as strip the Federal Reserve of its regulatory and supervisory authorities, which is necessary to eliminate the obvious conflict of interest involved with an institution that has on its board the leaders of those companies that it is expected to govern. The task of “unwinding” financial firms would be given to the FDIC, again with the cost being handed to other large financial institutions by way of various fees and taxes. One marked difference between the two legislative bodies is that the Senate bill would draw these fees from a broader base, specifically banks with assets totaling $10 billion, as opposed to the House bill’s $50 billion mark for fee requirement. Financial Transactions Tax and Insurance Fees The introduction of a financial transactions tax would strongly benefit Millennials. Not only would it be effective in mitigating the threat of future financial crises, but it would also go far in engraining a culture of sustainability in our financial sector, two results that would significantly improve our generation’s shortterm and long-term economic health. By limiting speculative (or “hot money”) flows, which promote volatility rather than sustainability, we would be ensuring that investors were focused on long-term objectives and building the real economy. This is precisely the kind of financing that Millennials will require as we start our own businesses, seek mortgages, and generally demand more capital from financial markets. Rep. Peter DeFazio introduced a separate bill in the House that would implement taxes on a variety of transactions, including those involving stocks, futures, swaps, and options. The precise tax rates would differ according to the nature of the transaction and would not include those initiated by mutual and pension funds nor any involving education and health savings accounts. Additionally, an individual or entity’s first $100,000 of transactions per year would be exempted, so as not to discourage investments by middle class Americans. Although Speaker Pelosi has voiced her support for this idea, at present it looks unlikely that it will make it out of the House Budget Committee. Senator Tom Harkin introduced identical legislation in the Senate that has not been eliminated by the Finance Committee. Nonetheless, with only three co-sponsors, it is highly unlikely that this legislation will make it to a floor vote or get attached to the Dodd bill unless there is considerable pressure brought upon House and Senate committee members.
Consumer Financial Protection Agency The creation of an independent CFPA would be quite advantageous for Millennials. The creation of a CFPA would streamline what is now a patchwork regulatory system that often obscures finance laws and encourages agency shopping among lenders. Our generation is too often the target of deceptive lending practices and risky financial consumer products like credit cards and loans. To prevent many Millennials from starting their lives in debt – and thus contributing to a negative long-term economic outlook for our country as a whole – this must be addressed and overcome. Better consumer protections are the key to doing so and are essential to the long-run financial stability of the country. Under the House bill, all financial products, including mortgage and credit cards, would be placed under the regulatory jurisdiction of the CFPA. Correspondingly, interpretive and enforcement power of consumer financial protection laws would also be granted to the CFPA. The discussion draft introduced in November by Senator Dodd also calls for the establishment of a CFPA. However, as he works with Senator Richard Shelby, his committee’s Ranking Member, on augmenting Republican support for the final version of the bill, some are speculating that the CFPA may be dropped from the bill. If this were to occur, the bill would place the jurisdiction for new consumer protections in a preexisting federal regulator, which most experts have agreed is essentially a toothless outcome. Reforming the Federal Reserve An enhancement of the Federal Reserve is in the best interest of Millennials. As it will continue to hold a preeminent position in our nation’s monetary policy and remain a leader in the financial sector, it must improve its transparency, accountability, and independence. In order for the Federal Reserve to accomplish these objectives, in the interest of avoiding conflicts of interest or its appearance, it should first institute longer waiting periods for banking-sector professionals looking to work at the Federal Reserve. It should also increase transparency by publishing the minutes of its Federal Open Market Committee (FOMC) meetings more rapidly and implementing tighter congressional oversight for any emergency policy measures. Finally, in absence of a separate and strong oversight entity, Congress should allow the Fed to maintain its regulatory authority over financial institutions, but not consumer financial products, thus pushing through a compromise that would allow the Fed to maintain authority while allowing a newly created CFPA to serve a crucial function. On this note, it should also be required to submit regular reports to Congress regarding risks to the financial system. The bill passed by the House requires the Government Accountability Office to perform an annual audit of the Fed. This was tacked onto the original bill crafted by Rep. Frank after more than 300 cosponsors signed onto an amendment originally introduced by Rep. Ron Paul. Despite the inclusion of this provision and others that would strip the Fed of some of its consumer protection powers, this bill does not go as far as the one offered in the Senate in terms of reforming the role of the Fed. The Senate bill calls for a more drastic reduction in the Federal Reserve’s role in banking regulation. Under Senator Dodd’s plan, the Fed’s only primary duty would be to conduct the nation’s monetary policy. Although his bill is consistent with the Obama administration’s views on most of the key issues in the debate of financial regulatory reform, this provision is directly at odds with their position, which emphasizes a continued role in financial regulation for the institution. Conclusion With negotiations continuing in the Senate, expect to see changes in the bill that will ultimately be voted on. Of course, the process of reconciling the House and Senate bills will also result in substantive modifications of the legislation. The hope is that these changes will ultimately produce serious reform of the financial industry that ushers in an era of financial security and sustainability.
The financial crisis that climaxed in the fall of 2008 served as an unexpected jolt to policymakers who had promoted deregulation in the financial industry for the better part of thirty years. This sudden crash, which can largely be attributed to the lack of effective oversight and regulation in the financial industry, has had immensely detrimental ramifications for both those within the industry and countless outsiders, such as small businesses who have seen their access to credit dry up and Baby Boomers who had spent a lifetime building up their pensions only to see them wiped out. If nothing else, this demonstrates that fundamental changes in financial regulation are absolutely necessary. In terms of what was at the core of this collapse, most economists agree, “the highly interconnected [regulatory] system failed because no one was in charge of spotting the risks that could bring it down.”1 Expansive monetary policy and excessive leverage fed a housing bubble and explosion in asset-backed securities. However, unlike other financial crises or asset bubbles, the housing bubble was, according to Robert Litan of the Brookings Institute, “fueled by a combination of excesses in the financial sector: imprudent mortgage lending, excessive leverage by financial institutions, and imprudent insurance or insurance-related activities.”2 Fortunately, central banks and ministries of finance across the world have reacted vigorously to the meltdown by extending support to large and small financial and insurance institutions. The United States’ primary intervention in the market came through the Temporary Asset Relief Program (TARP), which authorized the Treasury to spend $700 billion in purchasing toxic assets and injecting capital directly into financial institutions. These actions represented a far more robust response that that offered in the early days of the Great Depression and likely averted a far greater economic downturn. Moving forward, the American public and particularly Millennials stand to benefit from substantial reform. We realize that the deregulatory path, which essentially began in the Reagan administration and was highlighted by the 1999 Financial Services Modernization (Gramm-Leach-Bliley) Act, has led us astray from sustainable financial practices and will continue to produce crises like as the one we are currently mired in. Put simply, policy makers must effectively reform our financial regulatory system. While the House of Representatives has already passed a comprehensive bill, the Wall Street Reform and Consumer Protection Act (HR 4173), much work remains to be done as Senator Chris Dodd, the Chairman of the Senate Committee on Banking, Housing, and Urban Affairs, seeks to move his bill out of committee and attain passage in Congress’ upper chamber. As is often the case with complex legislation, this process will likely require an amalgamation of the two bills. Working within the context of the ongoing Congressional debate, we have identified five interconnected policies that must be implemented to achieve long-term financial security. First, we must reel in systemic risk and ensure that our financial system is able to handle volatility on the highest level. Similarly, we must also remove the implicit subsidies that financial institutions that are “too big to fail” currently receive. At the same time, we believe that implementing a tax on non-consumer-related financial transactions (i.e. the Tobin tax) would be instrumental in protecting taxpayers from paying for additional bank bailouts. Next, we believe that having a Consumer Financial Protection Agency is the best way to end deceptive lending practices and empower consumers to make wise financial decisions. Finally, reform of the Federal Reserve is needed to ensure that this preeminent institution achieves increased independence, transparency, and accountability.
We believe that these five issues are of utmost importance to Millennials given their immediate implications for our financial well-being and their impact on our nation’s long-term economic sustainability. Furthermore, our generation has witnessed the current economic downturn in some of our most formative years. Millennials having been more adversely affected than perhaps any other age bracket, with youth unemployment hitting 18.5 percent in July 2009, the highest July rate since 1948.3 Seniors graduating from college or high school can attest to the great difficulty of finding employment. Additionally, a generation ago, a single income earning middle-class families saved about 10% and had very little debt. Today, twoincome earning families are struggling to keep up with expenses, are no longer saving, and have racked up massive amounts of debt. This is because core expenses – mortgages, health care, costs of a second earner (more transportation, child care, taxes) – have skyrocketed. At the same time, more flexible costs (food, appliances, etc.) have decreased. A big part of this puzzle is that higher education costs have increased exponentially, and families simply cannot afford it anymore. What this all ultimately means is that our generation is walking into the above instability with massive amounts of student debt right out of the gate. These issues are enormously important to Millennials on a household-by-household level, and significantly affect the long-term financial prospects of millions of Americans – a factor that will impact generations. Acknowledging this, substantive reform is necessary to ensure our generation has enhanced long-term financial security. We understand that a failure to appropriately address these issues could prompt additional financial crises, the results of which would further indebt our generation and further erode our economic infrastructure. We must learn from the mistakes made and do our best to ensure that we are not in this position again. While recognizing the benefits of our free-market economic system, we insist that policy makers pursue smart regulatory practices that will end those industry activities that, on the aggregate, hinder our economy, while promoting those that provide helpful financial services to families and businesses.
1. Rivlin, Alice. “Reducing Systemic Risk in the Financial Sector” Remarks to House Committee on Financial Services and Senate Committee on Banking, Housing and Urban Affairs, 21 Jul. 09. < http://www.brookings.edu/testimony/2009/0721_ systemic_risk_rivlin.aspx>. 2. Litan, Robert. “Regulating Systemic Risk.” Brookings Institute. March 2009, 9. < http://www.brookings.edu/~/media/Files/ rc/papers/2009/0330_systemic_risk_litan/0330_systemic_risk_litan.pdf>. 3. Bureau of Labor Statistics, July 2009, http://www.bls.gov/opub/ted/2009/ted_20090828.htm 6
Systemic Risk Oversight
With regards to systemic risk in the financial sector, the main question is two fold: who should be in charge of supervising and regulating this risk, and how should it be done? Policymakers have come to a consensus that a new entity devoted to systemic risk regulation should be created, but have yet to designate who should act as regulator. The two predominant options are to propose either a new consolidated financial regulator, or delegate this responsibility to an existing body, such as the Federal Reserve. Recommendations based on Millennial Generation Priorities As Millennials, we understand that at the core of our current economic malaise is a failure to reign in systemic risk. Institutions with immense power operated irresponsibly and our economy is now suffering because of it. Moreover, our generation has also been disproportionately affected with youth unemployment being at historic levels, access to credit increasingly scarce, and the increasingly high debt our families are undertaking and that we possess upon joining the workforce. Thus, given the long-term implications of this issue, Millennials are inherently invested in reshaping financial regulation in order to curb systemic risk and promote a reinvigorated sense of stability in our macro-economy. We recommend that Congress begin by establishing a single consolidated financial regulatory agency to serve as systemic risk regulator (SRR), which by stabilizing the financial system would greatly lessen the threat of future financial tumultuousness and its associated consequences, such as high unemployment, as well as ensure that all people – especially Millennials - have access to credit (and thus allowing them to become first-time home-buyers, receive low-interest loans to college, etc.). As Litan put it, the SSR’s “mission must be clear: to significantly reduce the sources of systemic risk or to minimize such risk to acceptable levels.”4 Second, it must establish standards for identifying SIFIs. We believe that Congress should adopt the G30’s recommendations that emphasize size, leverage and degree of interconnection with the rest of the financial system as the deciding factors in such a designation. This entity must also be granted resolution authority and be required to issue regular reports outlining the nature and severity of any systemic risks in the financial system. Likewise, the SRR provide incentives for financial institutions to tie compensation with long-term performance, which, if done effectively, will greatly mitigate volatility in the financial sector. Additionally, hedge funds and their peers must be subject to leverage limitations directly tied to their perceived threat level. These funds should have reporting requirements to help the SRR and investors determine if any of the funds pose a significant systemic risk. Currently, there are no governmental requirements for comprehensive reporting by these funds. Finally, capital requirements must be higher for larger, more interconnected institutions, and these should increase as an institution’s systemic threat level rises.5 It is also vital that these SIFIs have an “early closure and loss sharing plan” to avoid the devastating consequences to the financial system we witnessed from the Lehman Brothers bankruptcy. In addition, they should be required to disclose their positions in the over-the-counter derivatives market to the SRR. Please note that this topic will be expanded upon in the following section. The House The bill crafted by Congressman Barney Frank and passed by the House in December calls for the establishment of a council of regulators that would oversee all banks and systemically important insurers. This entity, to be called the Financial Services Oversight Council, would be charged with monitoring macrolevel activity and periodically intervening in the financial services industry. This option is particularly at7
tractive because it is simple and intuitive. Litan envisions the consolidated financial regulator acting as the final authority on monitoring and implementing policy related to federally regulated financial institutions. He says that ideally a “solvency regulator, and not the Fed, would have clear authority and responsibility for overseeing all federally regulated financial institutions, including systemically important financial institutions (SIFIs).”6 Such a council would have the potential to force significant changes in the behavior of banks it deems a threat to the stability of the entire financial system, implementing controls that range from divestment instruction to discretion in investing techniques. Lastly, the committee would be given the power to draft “living wills” for banks. That is, the committee could pre-determine how a firm’s assets would be liquidated in the event the firm was considered a systemic liability and subsequently shut down. The Senate The bill currently being crafted by Senator Dodd calls for the creation of an entity with very similar powers to the House’s Financial Services Oversight Council. However, this entity would be an entirely new agency- tentatively named the Financial Stability Agency- with a board comprised of current regulators. As this proposed council approaches systemic risk primarily through the lens of the issue of “too big to fail,” this component of the Dodd bill is discussed in greater length in the following section. Alternative Perspectives In addition to these options, Congress could also designate SIFI risk regulatory tools to the Federal Reserve. One clear advantage of doing so is that the additional authority would actually make the Federal Reserve’s monetary policy job easier. After having seen that monetary policy, in-and-of-itself, would be unable to turn around the crisis, the Federal Reserve responded by testing the boundaries of its prerogative. Its capacities, however, were still rather constrained. Thus, some say that granting this added level of authority to the Fed could augment its effectiveness in dealing with such issues in the future. Of course, simply adding this authority to the Federal Reserve without the explicit addition of complementary policies, such as enhanced capital reserve requirements, would be unwise. As one would expect, there is concern that naming the Federal Reserve as the systemic risk regulator (SRR) could compromise its independence, a quality that is of paramount importance in the implementation of proper monetary policy. This is especially true in situations where the Federal Reserve raises interest rates in order to control inflation. Nonetheless, this concern may be misplaced because it is more likely that Congress and the Executive Branch will pressure the Federal Reserve to be more, not less, stringent in its regulatory activity. On this note, legislation unequivocally requiring the Federal Reserve to pursue its regulatory agenda more robustly would also be welcomed. Even after designating the institution that will have the power to monitor systemic risk and defining its capabilities, policymakers will still have the difficult task of deciding how to control systemic risk. Predictably, there are a myriad of perspectives available. The Treasury Department recommends: “higher capital and liquidity requirements for financial institutions, especially the largest, tougher regulation of systemically important financial institutions, expanded ‘resolution authority’ for regulators to take over troubled financial institutions, modest consolidation of regulatory functions, [and] new regulations for securitizations and derivatives.”7 Taking a slightly different approach, several economists recommend requiring the largest financial institutions to back a specific portion of their assets (e.g. 2%) with unsecured long-term debt, or subordinated
debt, to instill greater market discipline.8 This will help to diminish risk exposure, as “such debt has no upside beyond the interest payments it promises” and “its holder[s] are likely to more risk averse than common shareholders.”9 Meanwhile, Martin Wolf, the noted Financial Times columnist, has voiced options from a more conservative perspective. He is a strong proponent of Congress enacting laws that would “bankrupt any and all institutions, even in a crisis.” He is also in favor of raising the capital requirements for essentially all activities of financial institutions as well as eliminating “off-balance sheet activities.” Finally, he has advocated increasing the level of “contingent capital” that banks are required to hold.10 Despite the multitude of opinions available, there is emerging consensus on some issues. Chief among these is the belief among virtually all policymakers that once designated, SIFIs must have stricter capital and liquidity regulations than non-SIFIs. Ex post, it is clear that higher capital ratios would have limited the ability of large banks and financial institutions to get into such precarious situations and helped them endure the crisis once it had been started. Similarly, policymakers tend to agree that hedge funds and other private investment funds should be more transparent and that financial derivatives should be traded on regulated exchanges or at least via a central clearinghouse.
4. 5. 6. 7.
Litan 14. See footnotes 1, 4. See footnote 2, 11. Elliot, Douglas. “Reviewing the Administration’s Financial Reform Proposals. Brookings Institute, 17 Jun. 2009. <http:// www.brookings.edu/~/media/Files/rc/papers/2009/0617_financial_reform_elliott/0617_financial_reform_elliott.pdf>. 8. Acharya, Viral V, Richardson, Matthew, Roubini, Nouriel. What If a Large, Complex Financial Institution Fails? New York University: Stern School of Business. <http://w4.stern.nyu.edu/news/docs/what_if_a_big_bank_fails.pdf>. 9. See footnotes 2, 17. 10. Wolf, Martin. “Why curbing finance is so hard to do.” Financial Times, 10/22/2009. < http://www.ft.com/cms/ s/0/0a8a6362-bf3d-11de-a696-00144feab49a.html?SID=google>. 9
Curbing “Too Big To Fail”
The central question regarding institutions that are “too big to fail” (TBTF), as posited by Simon Johnson, former chief economist at the IMF, is “Should our biggest banks be broken up, or can they be safely reregulated into permanently good behavior?”11 He and many others have suggested that the big banks and insurance companies be broken up, while others argue that the greater size of financial institutions increase efficiency and improve competitiveness abroad. Recommendations Based on Millennial Generation Priorities This issue is naturally quite significant to Millennials given its potential effect on our long-term economy. Choosing to not address the phenomenon of “too big to fail” would only exacerbate this issue by letting the biggest banks grow more powerful, both economically and politically. This would have immense implications for the future of competition in the financial sector, highlighted by diminished consumer power and heightened barriers to market entry for new businesses. The latter is of particular concern for Millennials, given our generation’s entrepreneurial spirit, a value that has been fortified by the challenging labor market. As we begin to seek our first home mortgages and establish ourselves in the financial marketplace, this is development we must work to avoid. Moreover, the enduring nature of this issue disproportionately affects Millennials, as we have most all of our major financial decisions ahead of us. Acknowledging the above, we believe that Congress should ultimately adopt legislation that emphasizes several tenets. First, financial institutions must have increased capital and liquidity requirements, with a sliding scale that raises requirements as firms grow. Second, like President Obama, we support the implementation of a small fee on the some 35 financial institutions with over $50 billion in assets. This would be a wise measure in terms of eliminating the implicit subsidies that the biggest banks receive. This is also more preferable than a measure that would impose seemingly arbitrary limits on the size of financial institutions. Finally, we believe all hedge funds above a certain size should be publicly registered and included on a list that publicizes these and all systemically important financial institutions. This list would provide much needed transparency to the nebulous world of high finance and stimulate a more proactive approach to this issue. Overall, we believe that all of this paragraph’s recommendations should be incorporated into a comprehensive reform package. A piecemeal approach would only provide the illusion of financial security and set us up for another financial crisis in the future. The House With regards to the issue of TBTF, the House’s bill contains several strong provisions in addition to those more explicitly relating to systemic risk. First, under the current legislative language, the to-be-created oversight council would have the extraordinary ability to wind down SIFIs so as to avoid future governmental assistance in maintaining their solvency.12 The bill would also expand the powers of the Federal Deposit Insurance Corporation (FDIC). Much like their current power to disperse the assets of failed banks, the bill would empower the FDIC to unwind insolvent financial firms. They would essentially be executing the “living will” as drafted by the proposed oversight committee. Additionally, this manner of “unwinding” the risky financial institutions will ensure that shareholders and creditors, not taxpayers, bear the costs of the process. To this end, a “systemic dissolution fund” would be established through the FDIC and total up to $150 billion. Revenue for the fund would be generated through fees imposed on banks with assets totaling $50 billion or more and could be supplemented by borrowing up to $50 billion from the Treasury.
The Senate Like its House counterpart, the bill being crafted by Senator Dodd would give regulators the ability to further regulate the size and interconnectedness of financial firms, while ensuring that taxpayers aren’t left with the tab. Specifically, it would grant the proposed Financial Stability Agency the authority to force SIFIs to divest their holdings and generally downsize.13 This entity would have greater bureaucratic powers to preempt systemically risky financial services activity. The bill in its current form would also abolish the Office of Thrift Supervision and the Office of the Comptroller of the Currency as well as strip the Federal Reserve of its regulatory and supervisory authorities. In place of the above, the bill plans to create the Financial Institutions Regulatory Administration (FIRA), which would be chaired by a Presidential appointee and have the chairmen of the Federal Reserve and the FDIC as well as two independent members on its board. Such a consolidation in authority would constitute a severe advancement in institutionalized regulatory power. Finally, just as under the House bill, the task of “unwinding” financial firms would be given to the FDIC, again with the bill being handed to other large financial institutions by way of various fees and taxes. One marked difference is that the Senate bill would draw these fees from a broad base, banks with assets totaling $10 billion, rather than the House bill’s $50 billion mark. Alternative Perspectives Great public attention has expectantly been given to both bills, as they drive at the heart of our current recession and the corresponding financial crisis. Much public sentiment surrounding the bill has also focused on opposition to the Trouble Asset Relief Program (TARP), and the fact that taxpayers, via fiscal stimulus, were left to support failing banks. There seemed to be an uncomfortable consensus that the public was being held accountable for financial firms’ irresponsibility. Embracing such concerns, some argue that the legislation in both the House and the Senate will not alleviate the problems traced to the TARP, but actually worsen them. By institutionalizing relief to financial firms, the argument goes, the heart of the TARP will become engrained in the behavior of firms. Those who hold this view also doubt that dissolution funds would truly be taken from other banks, but rather, they fear that the taxpayer will inevitably bear the burden as under the TARP. Despite these concerns, we are confident that the measures recommended above would effectively eliminate moral hazard and the other incentives firms might have to operate irresponsibly as well as preemptively protect taxpayers from costly bailouts. To overcome this, the Chairman of the Federal Reserve, Ben Bernanke, has long advocated allowing select institutions to fail. He argues that by allowing any safety net for financial firms, however contrived, will create a moral hazard with regard to risky investing behavior. Backed by this logic, there are those who contend that any safety net is unwarranted and do not favor either the House or Senate bill. Of course, given the high short-term political and economic costs associated with allowing these institutions to fail, this course of action is unlikely to ever be endorsed by policy makers when push comes to shove. Others argue that big banks are more efficient, believing that economies of scale are stifled when banks are broken apart. Also, breaking up large banks may harm US firms’ ability to compete globally as some of their international competitors are even bigger. For this and the above reasons, many feel that any regulation aimed at TBTF institutions will do more harm than good. However, academic research shows that economies of scale in banking are quite limited and size and efficiency actually have a u-shaped relationship. Additionally, we have all sent the inherent danger that these financial institutions pose by having
so much economic and political power without commensurate regulatory limitations. Finally, the implicit subsidies TBTF institutions receive impede competition in the financial sector. Beginning to inch towards intervention, there are those who advocate simply limiting the size of firms. Their main arguments hinges on the belief that regulation of firms of this size has historically proven difficult if not impossible. Furthermore, their focus the size of institutions stems from their assertion that assessing the interconnectedness and levels of risky behavior can become too politically charged. Thus, they argue that simply limiting the size of firms to, say, $100 billion in assets would be the most effective. We disagree, viewing such a size cap as an arbitrary limitation that, while perhaps being easy to sell politically, is not the most effective economic solution. There has also been great debate over whether to publicly announce the SIFIs. Some argue that publicizing the SIFIs would be a moral hazard, making it more likely for those institutions to take on excessive risk. Others say that it is irrelevant because most knowledgeable financial investors and analysts would draw up the same list as the policymakers. Still, we believe that publishing the list of SIFIs may aid in monitoring and regulating them. Finally, President Obama recently released two proposals that would further reign in these SITIs. First, he has called for a tax- the “Financial Crisis Responsibility Fee”- on TBTF institutions. (Note: this is distinct from the aforementioned fee for the proposed “systemic dissolution fund.”) The primary idea would be to mitigate the implicit subsidies such institutions have received from this distinction and the associated governmental support. Of course, it would also raise substantial revenue for the federal government, the proceeds of which would likely be used to recoup the estimated $120 billion in losses from the financial rescue programs. The tax is designed to not apply to retail banking functions, but rather the banks’ highrisk operations, such as proprietary trading. The administration is also advocating the adoption of the so-called “Volker Rule.” According to President Obama, if this rule was adopted, “Banks will no longer be allowed to own, invest, or sponsor hedge funds, private equity funds, or proprietary trading operations for their own profit, unrelated to serving their customers.”14 Naturally, this would drastically impact these institutions’ trading units, which have consistently churned out profits. In principal, we are in favor of these two policy recommendations, though we are eager to learn more about the details.
11. Boone, Peter & Johnson, Simon. “Bernake on Banking.” New York Times Economix Blog, 10/29/2009. < http://economix. blogs.nytimes.com/2009/10/29/bernanke-on-banking/>. 12. Hamilton, James. “House Passes Historic Securities, Derivatives and Systemic Risk Reforms:HR 4173.” CCH Incorporated. Dec. 2010. < http://www.cch.com/press/news/CCHWhitePaperHR4173.pdf>. 13. Dodd, Chris. “Summary: Restoring American Financial Stability – Discussion Draft.” Senate Committee on Banking, Housing, and Urban Affairs. < http://banking.senate.gov/public/_files/FinancialReformDiscussionDraft111009.pdf>. 14. Obama, Barack. “Remarks by the President on Financial Reform.” The White House. 21 Jan. 2010. < http://www.whitehouse.gov/the-press-office/remarks-president-financial-reform>. 12
Financial Transactions Tax
One of the biggest lessons from this financial crisis is that the government must be financially prepared to deal with future uncertainties in our economy, which would go far in protecting taxpayers from paying for future bank bailouts, and address budget deficits. Perhaps the most effective way of accomplishing these objectives would be to impose a levy on the financial sector. Specifically, the implementation of a tax on non-consumer financial transactions should be used towards these goals. This tax is designed to curb short-term financial speculation, while simultaneously raising governmental revenue. This instrument would raise an estimated $100 billion in annual revenue if qualifying transactions were taxed at only 0.25%. These proceeds could be used towards a variety of policy initiatives, namely job creation projects or reducing of budget deficit.15 The former surely represents a positive reallocation of resources by creating more sustainable value for the economy. A study by the Congressional Research Service in 2004 also argues that the tax could, at least in part, be used to address the high compliance costs of current income tax laws and obtain revenues from the underground sector.16 These measures have also received support from prominent economists. James Tobin initially championed this idea, framing it as a way to reduce short-term speculation in currency trading and raising substantial revenue for international economic development. Lawrence Summers, currently the Director of the White House National Economic Council, has advocated for “some form of securities transactions tax” as far back as 1989. His academic research has discussed several of the fundamental questions raised by the financial transactions tax, such as which assets should be taxed, how the competitiveness problem should be addressed, how the parties involved and the nature of the transaction should be treated, and how to collect the taxes.17 Similarly, Dean Baker, co-director of the Center for Economic and Policy Research, promoted a security transaction excise taxes system with different tax rates for different types of securities.18 However, the globalized nature of our financial system could make implementing such a tax rather difficult, as any international inconsistencies would make enforcement a challenging task. Similarly, evasion could be an issue if this tax was not universally imposed. So, ideally we would like to see it adopted by all states, which would effectively eliminate regulatory arbitrage and tax evasion opportunities. Additionally, this tax, like any, would directly reduce transactions, which would reduce speculation in the marketplace, likely a net positive, but also cut down on liquidity, a more negative consequence. Nevertheless, several countries have implemented their own version of this tax, including the UK, Singapore, and Taiwan, though the US has not used a one since 1965. Also, New York State has demonstrated the feasibility of implementing this fee by levying a Stock Transfer Tax on all stock transactions, the proceeds of which are rebated afterwards. The SEC also charges a small transactions fee under Section 31 of the Securities Exchange Act to help pay SEC regulatory costs. Recommendations based on Millennial Generation Priorities The introduction of a financial transactions tax would strongly benefit Millennials. Not only would it be effective in mitigating the threat of future financial crises, but it would also go far in engraining a culture of sustainability in our financial sector, two results that would significantly improve our generation’s economic health. By limiting “hot money” flows, which promote volatility rather than sustainability, we would be ensuring that investors were focused on long-term objectives and building the real economy. This is precisely the kind of financing that Millennials will require as we start our own businesses, seek mortgages, and generally demand more capital from financial markets.
Although this idea may not gain much traction in the current political environment, we nonetheless urge that Congress give this proposal serious thought. While the implementation of such a tax could limit liquidity in the market, its implications for reducing capricious speculation and raising revenue would make the tradeoff an overall net positive. Also, considering that such a tax is could produce international arbitrage opportunities, the matter should be brought to appropriate global roundtables for further consideration so as to mitigate any negative implications it may have for our economy’s international competitiveness. The House Rep. Peter DeFazio introduced a separate bill in the House that would implement taxes on a variety of transactions, including those involving stocks, futures, swaps, and options. According to that piece of legislation (H.R. 4191), the precise tax rates would differ according to the nature of the transaction and would not include those initiated by mutual and pension funds nor any involving education and health savings accounts.19 Additionally, an individual or entity’s first $100,000 of transactions per year would be exempted, so as not to discourage investments by middle class Americans. Although Speaker Pelosi has voiced her support for this idea, at present it looks unlikely that it will make it out of the House Budget Committee.20 The Senate Senator Tom Harkin introduced identical legislation in the Senate that is currently being deliberated by the Finance Committee.21 With only three co-sponsors, it is highly unlikely that this legislation will make it to a floor vote. It has also failed to catch on with the Dodd bill, meaning its chances to become law are rather slim.
15. Goldman, David. “Taxing stock trades to pay for jobs” CNN. 2 Dec. 2009. < http://money.cnn.com/2009/12/02/news/ economy/financial_transaction_tax/> 16. Shvedov, Maxim, “Transaction Tax: General Overview,” (2004) CRS Report for Congress. <https://www.policyarchive. org/bitstream/handle/10207/1957/RL32266_20041202.pdf> 17. Summers, Lawrence H. and Victoria P. Summers  “When Financial Markets Work Too Well: A Cautious Case for a Securities Transactions Tax,” Journal of Financial Services Research, 3, pp. 261-86. 18. Pollin, R., D. Baker, and M. Schaberg, 2002. “Financial Transactions Taxes for the U.S. Economy,” Amherst: MA: Political Economy Research Institute, <available at http://www.peri.umass.edu/236/hash/aef97d8d65/publication/172/>. 19. DeFazio, Peter. Text of H.R. 4191: Let Wall Street Pay for the Restoration of Main Street Act of 2009. Govtrack.us. 3 Dec. 2009. < http://www.govtrack.us/congress/billtext.xpd?bill=h111-4191> 20. Rogers, David. “Nancy Pelosi pushes global financial fee.” Politico. 3 Dec. 2009. < http://www.politico.com/news/stories/1209/30200.html>. 21. Harkin, Tom. “Wall Street Fair Share Act.” Govtrack.us. 23 Dec. 2009. < http://www.govtrack.us/congress/bill. xpd?bill=s111-2927>. 14
Consumer Financial Protection Agency
This summer, the Obama Administration proposed via the release of a Treasury White Paper, the creation of an independent central authority to monitor and regulate financial products. This body, the Consumer Financial Protection Agency (CFPA), would assume all of the consumer protection roles previously delegated to the SEC, The Federal Reserve, FDIC, and the Comptroller of the Currency in monitoring consumer oriented financial services.22 Recommendations based on Millennial Generation Priorities The creation of an independent CFPA would be advantageous for Millennials. We understand that the creation of a CFPA would streamline what is now a patchwork regulatory system that often obscures finance laws and encourages agency shopping among lenders. Though no one is immune, we also realize that our generation is a disproportionate target for deceptive lending practices and risky financial consumer products like credit cards and loans. We know that we must overcome this to prevent many Millennials from starting their lives in debt. Better consumer protections are the key to doing so and are essential to the long-run financial stability of the country. Furthermore, as the Millennial generation ages, we will form the primary demographic of mortgage buyers. To avoid another sub-prime mortgage bubble, lending practices must be vigorously monitored. This financial crisis has taught us that consumers need guidance and responsible regulation to help them navigate financial services market. The CFPA will ensure that Millennials have this added support. The House Under the House bill, all financial products, including mortgage and credit cards, would be placed under the regulatory jurisdiction of the CFPA. Correspondingly, interpretive and enforcement power of consumer financial protection laws would also be granted to the CFPA. The agency would also be enabled to mandate disclosure guidelines to correct information asymmetry between borrowers and lenders, increase transparency, and ensure equity in the financial system. Importantly, the bill would also assign some degree of federal preemption, meaning that CFPA policies would act as a floor, or regulatory baseline, from which states could add tighter restrictions. It should also be noted that prior to formally introducing the bill, Chairman Frank stripped it of a controversial provision that would require all lenders to provide “plain-vanilla” products (i.e. low-limit, lowinterest credit cards and 30 year fixed-rate mortgages) to borrowers. Naturally, many financial services firms opposed that clause due to their fear that the mandatory inclusion of these “plain vanilla” products would crowd out more profitable customized lending products. We feel that it would have been wise to include it in the final bill, as the financial crisis showed us that the detriments associated with having an over-saturation of the most risky and complex financial products in the lending market. Also, in the Energy and Commerce Committee markup, Rep. Waxman further amended the bill so that it would establish a five-person commission to govern the CFPA, rather than a single chairman as outlined by the administration’s original proposal. Additionally, the bill that was ultimately passed narrowly maintained the CFPA provisions, after an amendment Rep. Walter Minnick’s amendment to use a council of regulators for consumer protection instead of the CFPA came close to passing. The Senate On November 10th, Chairman Dodd introduced a discussion draft of his bill “Restoring American Financial Stability,” that also calls for the establishment of a CFPA. However, as he works with Senator Richard Shelby, his committee’s Ranking Member, on augmenting Republican support for the final version of the
bill, some are speculating that the CFPA may be dropped from the bill.23 If this were to occur, the bill would place the jurisdiction for new consumer protections in a preexisting federal regulator. This seems relatively feasible given the difficulty Democrats may have in garnering a filibuster-breaking 60 votes on Dodd’s current bill. If this were to occur, the bill would place the jurisdiction for new consumer protections in a preexisting federal regulator, which most experts have agreed is essentially a toothless outcome.
22. “Financial Regulatory Reform: A New Foundation.” U.S. Department of the Treasury. < http://www.financialstability.gov/ docs/regs/FinalReport_web.pdf>. 23. Dennis, Brady and Binyamin Appelbaum. “Sen. Dodd may drop push for consumer financial protection agency.” Washington Post. 16 Jan. 2010. < http://www.washingtonpost.com/wp-dyn/content/article/2010/01/15/AR2010011504054.html>. 15
Reforming The Federal Reserve
The mission of the Federal Reserve has historically been to maintain price stability and full employment in the United States through conducting monetary policy. Beyond this, the Fed’s duties also currently include regulation of the banking industry and informal management of systemic risk in the economy.24 Controversial since its inception, debate has escalated since the beginning of the financial crisis over the Fed’s future role in managing the financial system. Acknowledging these sentiments, Senator Charles Schumer remarked that, “Whether rightfully or wrongly, [the Fed] is highly unpopular with the left and the right.”25 Thus, it comes as no surprise that many throughout the political spectrum support reducing the regulatory role of the Federal Reserve and augmenting its transparency. Espousing a common view on the former, AFL-CIO President Richard Trumka remarked that he “cannot support” any bill that does not remove banks from the “governance of the Federal Reserve System.”26 With regards to the latter, many are in favor of auditing the Fed and enacting rules to enhance its independence from the financial sector. Recommendations based on Millennial Generation Priorities An enhancement of the Federal Reserve is in the best interest of Millennials. As it will continue to hold a preeminent position in our nation’s monetary policy and remain a leader in the financial sector, we desire that it improve its transparency, accountability, and independence. We also realize the importance of the Fed’s role on the global stage and thus want it to be the world’s leading central bank. We are confident that our recommendations for this institution would go far in ensuring that the Fed does a better job steering our country’s financial sector- an objective key to America’s success in the decades to come. First, the Federal Reserve must balance autonomy and accountability. The importance of having an autonomous central bank that sets interest rates without regard to political pressures should not be discounted. There is strong evidence demonstrating a correlation between average inflation and the degree of central bank independence across countries.27 This is traditionally attributed to improved credibility and consistency by more independent banks, and it should serve as a warning against calls to completely dismantle or eliminate the authority of the Federal Reserve. However, based on the recent crisis, it is clear that reform is necessary to better address the issues of longer-term systemic risk and potential pressure that may threaten the Federal Reserve’s independence from the financial industry. Second, legislation should separate Wall Street from Washington. Many Americans are concerned that the same individuals who fueled speculation and unsustainable risk-taking over the last decade are managing the nation’s financial system. Much of the current outrage stems from concerns that the recent bailouts imply the Federal Reserve and Executive Branch officials are more concerned about the losses of big banks than those of average Americans. Mandating longer wait times for an individual to switch employment between the banking industry and the Federal Reserve would be a good start in solving this problem. Additionally, it is disconcerting that many of the current Federal Reserve Board Members are from the banking and financial industries, and that the current New York Federal Reserve Branch has more assets and influence than the other regional banks. Emphasizing a wider distribution of individuals on the open market committee, by both industry background and geographic location, would help to maintain a better checks-and-balances approach to regulation. The Federal Reserve’s opaque decision making processes and general operations have also contributed to recent criticism. Legislation can and should improve transparency, while retaining independence. One solution is for the Fed to release more information. For example, the Fed could lessen the amount of time it takes to release its minutes, even if this does not extend to opening every meeting to the public. Stricter oversight of emergency measures in the medium and long-term would also provide some oversight of po16
tentially questionable practices, while maintaining short run flexibility. Additionally, the Federal Reserve needs to enhance its role in financial regulation. In its current incarnation, there is a clear tension between the Federal Reserve’s regulatory duties and its responsibility to maintain economic stability. Interestingly, Chairman Bernanke is opposed to the creation of a CFPA and the corresponding diminution of the Fed’s powers in consumer protection, arguing that the Federal Reserve’s knowledge will allow it to regulate banks most effectively and is necessary for it to retain its authority. A compromise solution would allow the Federal Reserve to retain some of its authority over banking regulations which are independent of consumer protection, but it would require much greater oversight and more frequent reports to Congress over risks to the financial system than its traditional monetary policy responsibilities. The House The bill passed by the House requires the Government Accountability Office to perform an annual audit of the Fed. This provision was tacked onto the original bill crafted by Rep. Frank after more than 300 cosponsors signed onto an amendment originally introduced by Rep. Ron Paul. The case for doing so was recently strengthened by the release of emails indicating that attorneys working on behalf of the NY Fed advised AIG to not disclose that they would be paying the counterparties on their credit default swaps 100 cents on the dollar.28 Despite the inclusion of this provision and others that would strip the Fed of some of its consumer protection powers, this bill does not go as far as the Senate one in terms of reforming the role of the Fed. The Senate Senator Dodd’s plan calls for a drastic reduction in the Federal Reserve’s role in banking regulation. Under his plan, the Fed’s only primary duty would be to conduct the nation’s monetary policy. Although his bill is consistent with the Obama administration’s views on most of the key issues in the debate of financial regulatory reform, this provision is directly at odds with their position, which emphasizes a continued role in financial regulation for the institution. Naturally, the Federal Reserve is also opposed to this part of the legislation, with Chairman Bernanke arguing that supervising financial institutions is a core mission for the Fed.
24. “Federal Reserve Bank: Mission.” Federal Reserve Board of Governors. <http://www.federalreserve.gov/aboutthefed/mission.htm>. 25. Cho, David, et al. “Dodd’s reform plan takes aim at the Fed.” Washington Post. 11 Nov. 2009. <http://www.washingtonpost.com/wp-dyn/content/article/2009/11/10/AR2009111019995.html>. 26. Trumka, Richard. Congressional Testimony. 29 Oct. 2009. <http://www.aflcio.org/mediacenter/prsptm/tm10292009.cfm>. 27. Alesina, Alberto and Lawrence H. Summers. “Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence.” Journal of Money, Credit and Banking, Vol. 25, No. 2. May, 1993, pp. 151-162. http://www.jstor. org/pss/2077833. 28.Freed, Dan. “Fed Audit Case Boosted by AIG Emails.” TheStreet.com. 8 Jan. 2010. < http://www.thestreet.com/story/10657735/1/fed-audit-case-boosted-by-aig-emails.html?cm_ven=GOOGLEFI>. 17
“20 ways US House, Senate financial reforms differ.” Reuters. 6 Jan. 2010. Amel, Dean et. al. “Consolidation and Efficiency in the Financial Sector: A Review of International Evidence.” Working Paper, 8/15/2002. Baily, Martin & Litan, Robert. “Regulating and Resolving Institutions Considered “Too Big to Fail.” Remarks to the Senate Committee on Banking, Housing and Urban Affairs, 5/6/2009. Baker, Dean. “The Benefits of a Financial Transactions Tax.” Center for Economic and Policy Research. December 2009. Denis, Brady and Binyamin Appelbaum. “Sen. Dodd may drop push for consumer financial protection agency.” The Washington Post. 16 Jan. 2010. Boone, Peter & Johnson, Simon. “Bernanke on Banking.” New York Times Online Economix, 10/29/2009. Elliot, Douglas. “Initial Comments on the Draft House Bill on Systemic Risk and “Too Big to Fail.” Brookings Institute, 10/28/2009. Elliot, Douglas. “Reviewing the Administration’s Financial Reform Proposals.” Brookings Institute, 6/17/2009. Herbert, Bob. “Where the Money Is.” The New York Times. 12 January 2009. Indiviglio, Danile. “Should New Taxes Fund Future Bailouts?” The Atlantic. 29 Sept. 2009. Johnson, Robert (Ed.) Make Markets Be Markets. The Roosevelt Institute. 3 March 2010. Johnson, Simon. “In Banking, Bigger is Not Better.” New York Times Online Economix, 10/22/2009. Johnson, Simon. “Will the Banks Sort Themselves Out?” New York Times Online Economix, 6/25/2009. Litan, Robert. “Regulating Systemic Risk” Brookings Institute, 3/30/2009. Litan, Robert. “Three Cheers for Treasury’s Plan for Regulating Systemic Risk.” Brookings Institute, 3/30/2009 Mishkin, Frederic. “How Big of a Problem is Too Big to Fail” National Bureau of Economic Research Working Paper, 12/2005. Rivlin, Alice. “Reducing Systemic Risk in the Financial Sector.” Remarks to House Committee on Financial Services and Senate Committee on Banking, Housing and Urban Affairs, 7/21/09. Rivlin, Alice. “Systemic Risk and the Role Federal Reserve.” Brookings Institute, 7/29/2009. Tahyar, Margaret E. “House Passes Wall Street Reform and Consumer Protection Act.” The Harvard Law School Forum on Corporate Governance and Financial Regulation. 29 Dec. 2009. Wolf, Martin. “Why curbing finance is hard to do.” Financial Times, 10/22/2009. To learn more about theRoosevelt Institute Campus Network, go to www.rooseveltcampusnetwork.org.
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