Overview of the proposed regulatory changes

I feel as if the talk of regulatory change is one of the most important national discussions taking place right now. Count on continued updates here on ze blog outlining the proposed steps.

The rumbling in the District of Columbia is as follows:

• giving the Federal Reserve new powers, including…
  – the ability to monitor broad risks that could potentially affect the economy
  – the ability to take mitigating actions against identified risks

Commentary: As you know, I have been saying for months that it was important that a single regulator have great transparency into the financial risks being taken within the economy. I am hopeful this will include disclosure on the part of hedge funds and private equity investments that matches the disclosure requirements of mutual funds. I am a 100% supporter of this sort of a change. What’s more, consolidating the regulatory structure will prevent financial institutions and their lawyers from crafting corporate and business charters in such a way as to be regulated by the regulator who is least empowered to do so legally. One regulator – one law – single enforcement.

• more stringent capital requirements for banks

Commentary: This will likely include limits on the types of risky investments that banks can make. There were already limits imposed, however a toughening of these standards will reduce the amount of risky bets that banks can legally take. Amen!

• the ability of regulators to take over large financial firms

Commentary: Currently business managers are barely feeling the consequences of their “head and the sand” choices of the last decade. Executives scarcely fear losing their jobs and most still are receiving bonuses. I am all about positive and negative financial incentives for motivating those motivated by money. What could put the “Fear of God” into an executive faster than knowing that the Feds could come in and take over their “little corporate baby?” This step is bound to strongly help scare executives onto the straight and narrow. Double amen!

• overhaul of the oversight of the “payment & settlement” system

Commentary: Most folks don’t know that banks are not required to hold cash on hand to cover all of their depositors monies. For example, if you take $100 to the bank to deposit, the bank is not required to keep all of your $100 on hand. So what happens if you should decide to want to withdraw your funds? Since only a handful of depositors on a given day make withdrawals, banks are only required to keep on hand a specific percentage of their deposits in the form of cash or cash equivalents. The % that is required to be on hand varies based on the perceived strength of the bank. Thus, if a bank has a shortfall of cash at the end of the day they are required to borrow cash or cash equivalents from an institution with excess reserves. In the most recent crisis, banks were reluctant to lend money to failing institutions for fear that they would not get their cash back. Additionally this “payment & settlement” system also allows for the clearing of financial transactions, such as checks that have been written. Unfortunately, the oversight of this function was less than perfect. Improved oversight here will help to prevent the sort of instantaneous credit market freeze that happened last fall.

• the creation of a derivatives clearing house

Commentary: This would create single-regulator transparency so that knowledge of the risk of derivatives is better understood so that regulators can act more effectively. Again, this is crucial if another financial catastrophe is to be averted and has my 100% support.

As these plans evolve the details will change. However, this stuff is so important that it behooves each of us as citizens to really pay attention to what it happening on this front.

Respectfully,

Jason