Financial Regulatory Reform As president, Governor Huntsman will make financial regulatory reform a high priority.

Real financial reform will mean breaking the Faustian bargain between Wall Street and Washington that helped fuel the housing bubble, drove a series of bailouts, and prevented meaningful reform in the aftermath of the financial crisis. More specifically, real reform means repealing the 2010 Dodd-Frank law, which perpetuates too-bigto- fail and imposes costly and mostly useless regulations on innocent smaller banks without addressing the root causes of the crisis or anticipating 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 state hands, for example in Europe. To remain competitive, America must think differently. We need to start thinking prospectively about an evolving and complex financial system. But this cannot mean that the government allocates credit. We need the market to allocate credit, without the kinds of subsidies that encourage a build-up in dangerous amounts of borrowing and leverage anywhere in the economy. ENDING TOO BIG TO FAIL Today we can already begin to see the outlines of the next financial crisis and bailouts. More than three years after the crisis and the accompanying bailouts, the six largest U.S. financial institutions are significantly bigger than they were before the crisis, having been encouraged by regulators to snap up Bear 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 nearly triple 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 the next financial shock. Anything that is too big to fail is simply just too big – with the real danger that large banks have the incentive and ability to become even bigger. Next time, the largest banks may be so big that their failure will swamp the fiscal balance sheet of the government. If we let today’s financial 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 to GDP. In some European countries, one bank can bring down the nation. Why would we want such unfair and inefficient arrangements in America? Explore reforms now being considered by the U.K. to make the unwinding of its biggest banks less risky for the broader economy. Impose a fee on banks whose size exceeds a certain percentage of GDP to cover the cost they would 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 so would 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 financial system to absorb them organically in the event of a collapse. Strengthen capital requirements, moving far beyond what is envisioned in the current Basel Accord. 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 a financial system that has more equity financing and relatively little debt financing. Eliminating subsidies would encourage the affected institutions to downsize by selling off certain operations or face having to pay the real costs of bailouts. Removing the taxpayer subsidies that create too-big-to-fail will also strengthen local and community banks that are unable to compete with the subsidized 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. MAXIMIZING DERIVATIVES TRANSPARENCY As president, Jon Huntsman’s administration will be committed to enhancing transparency in the derivatives markets. An opaque derivatives market was one reason for the systemic impact of the subprime mortgage crisis. Greater transparency will permit greater oversight by both market participants and 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 minimize the 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 Chicago

Board of Trade are already subject to such measures. REPEAL DODD-FRANK 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 the summer of 2010 ignored the government’s pervasive role in causing the crisis, assures future transfers from taxpayers to bankers by institutionalizing a government backstop for too-big-to-fail firms, and imposes massive new regulations and unreasonable compliance costs on smaller financial firms. As a result, lending to small businesses from small banks has suffered. There is no better example of the perverse incentives of Dodd-Frank than Bank of America’s decision this fall, when faced with a credit downgrade, to move part of its derivatives book from Merrill Lynch to another subsidiary that was covered by FDIC insurance. The move was possible only with the agreement of 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 financial markets. END WALL STREET’S RELIANCE ON EXCESSIVE SHORT-TERM LEVERAGE 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. As president, 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 nonfinancial sector and good for well-run smaller financial firms. But the subsidies to large, highlyleveraged financial firms 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. FIXING BASEL Governor Huntsman believes that risk needs to be acknowledged and managed properly. The Basel III Accord 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 all investment assets, including sovereign debt; those assessments should not be limited to the Eurozone member states, but extend to all states whose debt carries potential risk. Banks will make these assessments not because a regulator or government official tells them what the appropriate risks are, but rather because – if they don’t get it right – they will face the risk of real failure. Creditors must understand that the era of “moral hazard” is over. Europe today shows us what happens if we do not eliminate bailouts; they will continue to get bigger and bigger, until they either ruin us through the effect on government debt or lead to excessive inflation due to the actions of our central bank (or both).

STABLE DOLLAR POLICY Governor Huntsman supports a strong and stable dollar. As president, he will appoint Federal Reserve Board Governors and a Chairman who believe in sound money. The United States cannot devalue our way to prosperity and efforts to do so risk a “beggar thy neighbor” round of devaluations which will ultimately harm American exporters and risk the dollar’s privileged position as the primary global reserve currency. The main risk to the dollar is that the Federal Reserve will feel empowered to create more money to provide bailouts to troubled large firms, and to deal with the unemployment levels caused by major financial crises. Eliminating too-big-to-fail has consequences in terms of making the macroeconomy more stable because it removes a major incentive for the Federal Reserve to run a loose monetary policy. SHUTTING DOWN FANNIE MAE AND FREDDIE MAC As president, Governor Huntsman will dismantle Fannie Mae and Freddie Mac. Eliminating the GSEs should not be controversial. At its heart, the Panic of 2008 was a crisis born of crony capitalism. It is unconscionable that five years after the start of the housing crisis these companies have not seen a serious reform proposal and most of their executives are still in power. Today Fannie Mae and Freddie Mac purchase more than 90 percent of new mortgage originations. This is not evidence of the lack of a private market for loans but is an illustration of a private sector forced to cede the field due to an inability to compete with state subsidies. The firms cannot be unwound overnight nor can they simply be privatized. Pure privatization would result in new systemically risky too-big-to-fail private sector institutions. Jon Huntsman’s administration will oversee the creation of a new Resolution Trust Corporation along the lines of what was used to resolve the savings and loan crisis of the 1980s. This reconstituted RTC will sell off Fannie’s and Freddie’s assets. Its predecessor was able to close almost 800 thrifts in six years; the unwinding of Fannie Mae and Freddie Mac should be accomplished in a somewhat longer but similar time frame. Governor Huntsman will establish genuine competition in this market, with no one having the political or economic power to extract subsidies from the government. At the same time, his administration will ensure there is appropriate and full application of the rule of law within the mortgage sector. The property rights of homeowners must be fully protected under all circumstances. Our market economy is not based on the notion that it is “one set of rules for you” and “another set of rules for the big players.” Credible accusations of legal violations should be investigated fully, whether or not the alleged perpetrators are big banks. RESTORING RULE OF LAW Jon Huntsman’s administration will direct the Department of Justice to take a lead in investigating and brokering an agreement to resolve the widespread legal abuses such as the robo-signing scandal that unfolded in the aftermath of the housing bubble. This is a basic question of rule of law; in this country no one is above the law. There are also serious issues involving potential violations of the securities

laws, particularly with regard to fair and accurate disclosure of the underlying loan contracts and property titles in mortgage-backed securities that were sold. If investors’ rights were abused, this needs to be addressed fully. We need a comprehensive settlement that puts all these issues behind us, but any such settlement must include full redress of all legal violations. EUROPEAN SOVEREIGN DEBT CRISIS The recent failure of MF Global illustrates the danger that the unfolding sovereign debt crisis poses for domestic financial markets. The world works better when the United States leads and as president, Jon Huntsman will be supportive of a European-led global response to the ongoing crisis; the pell-mell response to date has created additional uncertainty, worsening the crisis. This is, in the end, a European problem that must be addressed by the Europeans. The Eurozone does not have a balance of payments problem at the level of the currency union and does not need an external loan of any kind. The Europeans created a monetary union without any kind of meaningful fiscal union. They need a new constitution, just as the United States needed one in 1787. We can help them have the hard conversations and point them in the right direction; they could learn a great deal from the fiscal consensus forged by Alexander Hamilton and Albert Gallatin. But the Europeans ultimately have the ability and the pressing need to sort out their own problems. Ultimately, the only solution to the crisis is growth. As president, Jon Huntsman will advocate for progrowth structural reforms in Europe and lead by example by making structural reforms at home. We need innovation that creates good jobs for all Americans. The private sector needs to do this, but the government must be supportive, particularly with regard to strengthening education at all levels. Free and fair competition is what has brought the United States to its current level of prosperity, and this must be what carries us forward.


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