Written by Jim Patterson
Complicated new regulations added to complicated old regulations won鈥檛 protect the United States鈥� financial system from frightening crashes like that experienced in 2008, says a Vanderbilt professor who helped the Obama administration pull the financial sector out of that morass.
Instead, 鈥渁 much simpler and more surgical approach is needed,鈥� said of , author of (The University of Chicago Press).
“Shadow banking”
What Ricks proposes cutting out is the pervasive practice of Wall Street institutions funding their operations through very short-term debt markets, where debt matures as often as daily.
This practice, sometimes called shadow banking, results in funds being continuously rolled over. That鈥檚 when 鈥渢he problem of runs and panic emerges,鈥� Ricks said. 鈥淭hat鈥檚 really what we ought to be trying to prevent.鈥�
The economy could have weathered the 2008 burst of the housing bubble if it were not built on a rickety surface of short-term obligations, Ricks maintains.
Panic-proof policy
Instead of focusing on preventing another bubble or mitigating 鈥渟ystemic risk,鈥� Ricks said, financial policy should concentrate on ensuring a system that is stable and panic-proof.
In order to do this, entities that lack a banking charter should be prohibited from using large quantities of short-term or demandable debt, continuously rolled over, to fund portfolios of financial assets, he said.
When they are allowed to operate as they do now, the liabilities they incur are more or less equivalent to bank deposits. However, banks, unlike securities firms, must be chartered and abide by numerous regulatory restraints in exchange for the privilege of using their deposits as money substitutes. Securities firms do the same thing with short-term borrowings without the same regulation or oversight, Ricks said.
鈥淲hat we鈥檙e essentially allowing the financial sector to do is create money substitutes without requiring them to have any kind of license or abide by any regulatory constraints to do so,鈥� Ricks said.
Less-complex regulation
Ricks, associate professor of law, started developing his proposal while still working as a financial restructuring expert at the U.S. Treasury Department. In exchange for the loss of financing via short-term debt, Ricks鈥� plan calls for securities firms鈥� being freed from many of their regulatory constraints.
鈥淭he financial regulatory regime we have now is mind-bogglingly complex,鈥� he said. 鈥淚 teach the stuff, and I can鈥檛 keep up with it.鈥�
More time to mature
If Ricks鈥� plan were implemented, Wall Street would have to adjust and use longer-term debt 鈥� that matures in a year or longer instead of a day 鈥� to finance their activities.
Although the change could make Wall Street鈥檚 operation more expensive, Ricks thinks his approach should be appealing to both conservatives and liberals. 鈥淚 think there鈥檚 something here to like irrespective of your political persuasion. I think 鈥� the left would appreciate that it is a structural reform, not a tweak of existing systems that have clearly not worked well.鈥�
On the right, he said, the reform would be 鈥渕uch more deliberate and surgical and cast a much narrower net as opposed to a wider net in how we deal with regulating the financial system for stability purposes, and I think that should appeal to people who want less regulation.鈥�