Six Real Reforms for the Banks

02/24/2010 10:51 am EST

Focus: MARKETS

Michael Brush

Columnist, MSN Money

Michael Brush of MSN Money says some of the Obama administration’s plans to deal with the banks fall short, and recommends six things he says will really work.

Early last month, President Obama proposed a "financial crisis responsibility fee" for banks with more than $50 billion in assets. The idea is to raise $100 billion or so to make sure the bank bailout is repaid in full.

[Later], the president came out with a second proposal. Known as the "Volcker rule," after Reagan-era Federal Reserve chairman Paul Volcker, it would bar banks using federal deposit insurance from trading for their own account (known as proprietary trading) or running hedge funds or private-equity trading shops. This is an attempt to downsize banks and keep them out of risky activities. It falls short on both counts.

So, let's look at six key reforms the experts say we really need:

1. Scale back the big banks. Huge banks at some point become "too big to fail," which means they'll get bailed out by the government if they get into trouble. This frees them to take wild risks. One fix could be to cap bank size relative to the size of the economy. Another fix would be to increase the amount of capital that banks have to hold to back riskier businesses.

2. Fix the pay packages. Top bankers stand to reap huge rewards from stock options and restricted stock, as well as cash. This sets up distorted incentives. They lose little if their banks go bust but reap big gains if risky moves pay off. No one in Washington seems ready to deal with this issue.

3. Fix the Securities and Exchange Commission. Much of the blame for the financial crisis lies with the SEC, says William Isaac, [former head of] the Federal Deposit Insurance Company and financial-sector consultant with LECG, a consulting group. But nothing in the [current] House bill on financial reform would toughen this market watchdog.
 
4. Streamline banking regulation. Too many different regulators at the Treasury Department, the Federal Reserve. and elsewhere in Washington oversee our banks. Banks can play [regulators] against each other in a game called regulatory arbitrage.

5. Increase consumer protection. It's easy to blame the financial meltdown on people who took out subprime mortgages for getting in over their heads or signing contracts they should have understood. But plenty of real-estate agents [may have changed] the terms of mortgages without telling borrowers or [buried] key material in incomprehensible fine print, [author Andrew] Cockburn says.
 
A proposed Consumer Financial Protection Agency, now before Congress, might [require] more clarity in the contracts behind mortgages, credit cards, and other financial products. But the agency may not survive the Senate.

6. Put complex derivatives on an exchange. The meltdown, of course, wasn't just about mortgages. The system blew up because banks and AIG used those mortgages to create complex derivatives that were nearly impossible to value, putting too much risk on their balance sheets.

If derivatives were traded on a central exchange, as stocks are, someone could monitor positions and make sure banks that owned them had enough capital to sustain losses if they blew up.

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