Thursday, January 31, 2013

- Effective Banking Reform

You would guess (certainly my liberal critics would guess) that as a hedge fund guy with nearly 25 years total experience on Wall Street, I'd be against a reform that placed additional burden on banks. But you'd be wrong. I love this idea (presented in National review bu University of Mississippi Economist Joshua R. Hendrickson. Let me tell you why.

The problem with the American financial industry right now is not that the rules are too restrictive, although in some areas they certainly are. The problems (really) is that the rules are stupid. They are drafted by third parties in Washington who have only a passing acquaintance with how the banking industry really works, and they are designed to achieve political goals, not economic or financial ones. No one is so smart that they can interfere in a third part process and make things more efficient than the people involved would make them on their own.

But Washington's plan is to do that very thing. Make the banks into utilities where all the relevant decisions are made in Washington for political reasons. Want a new result? Make a new rule. It's appropriation by regulatory fiat. Rather than honestly seizing the means of production as Communists would do, our post communist left has decided to rule by intrusive bureaucracy instead. And so long as the rules aren't spelled out the industry will remain frozen in place like a Deer in the headlights. No vigorous growth will commence until the private sector believes the new rule making is finally done.

But as soon as we finally put the brakes on in Washington, the industry will grow again. Innovating around the 'stupid' rules that Washington makes is what Wall Street does. (Innovating around the 'stupid' rules about minority lending is what caused the mortgage crisis in the first place.) The entire swaps industry and most of the derivatives industries were built for that very reason. As were many of the practices pertaining to taxes, and the very workings of the markets themselves.

But as you can probably see, that innovation doesn't necessarily solve the problem. A market that Washington has broken stays broken, even when the banks innovate enough to save themselves. Prof. Hendickson's rule, in my opinion, would end that. It would decimate the stock prices of the banks of course, but that would be a short term effect. Once the rule was in place and the value of it assessed, then the banks could start innovating again and in ways that are responsible about risk and enhance profitability.

It's a 'self adjusting rule' that puts the power in the hands of people who best know what they should do and are most at risk when it's done. Put another way, it takes the power out of the hands of the people who don't know what they're doing in Washington, and puts it in the hands of people who do know what they're doing at the banks. But since they risk their own money and not the money of taxpayers, they will either act prudently or be replaced by someone else who does.

No matter what the pols in Washington may say about "too big to fail", keeping taxpayers on the line is exactly how they want it. "Too big To fail" was a Washington creation, not a creation of the market. And so long as it's in place, it leaves know nothing bureaucrats with no skin in the game in control of the banks - even though they don't know how to run a bank, or for that matter how to effectively run a government.

Putting it all back on the banks themselves is a way to finally start to see them grow in healthy ways again. Prof Hendrickson has the right idea.

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