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Risk and reform

 

The public clearly wants financial regulatory reform. A new ABC News/Washington Post poll found that more than two-thirds of Americans favor tougher oversight of banks and other financial institutions.

The margin was even larger in last week’s RBJ Daily Report Snap Poll. Eighty-seven percent of the nearly 600 respondents said they think regulation of the nation’s financial system needs reform.

But when the question becomes how regulations should be revamped, views are more closely split. For instance, only 57 percent of Snap Poll respondents agreed that to prevent future bailouts, limits should be placed on the size of the nation’s largest banks.

This unsettled view of financial regulatory reform reflects the legislation now being debated on Capitol Hill. Both the Senate and House bills would reshape the nation’s financial system.

In fact, the size and complexity of lawmakers’ proposed remedy for the financial system’s ills hardly inspires confidence. If anything, the crisis of 2008 underscored the need for clear, readily enforceable rules that reduce systemic risk.

A better approach might be to focus on a few key reforms. One would be a more prudent approach to derivatives, which helped turn the subprime mortgage crisis into a systemwide collapse. The first step should be creation of a standardized, transparent market for most derivatives.

Beyond that, as former University of Rochester president Thomas Jackson argued in a recent Wall Street Journal op-ed piece, derivatives no longer should be exempt from many bankruptcy rules. This simple change "would reduce the need for bailouts" by allowing for a more orderly resolution than derivatives creditors demanding collateral or canceling their contracts.

Similarly, many experts think a straightforward bankruptcy process for failing financial institutions would be much better than giving regulators broader discretion for bailouts. And limiting banks’ leverage is an idea that few argue with.

The need for reform is urgent; as time passes, the political will to enact it is likely to fade. However, pushing through a vast array of barely understood or ill-advised changes would have consequences too.

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