An Example of a Simple Fix to a seemingly complex issue available to us now

A significant issue within our current American system is the massive expansion in regulatory complexity. Acts/Laws, Rules and Regulations thousands of pages in length have replaced much simpler and more effective versions put in place during times of crisis when our legislative branch was far better at working together and resisting outside influence.

For example, the Glass-Steagall Act of 1933 separating commercial and investment banking was 37 pages and helped prevent another depression until it was weakened and then effectively repealed in 1999. It was replaced with Dodd-Frank in 2010, which is 2300 pages in length.

Another example is Obamacare, which is roughly 20,000 pages of 8 x 10 paper. Medicare-for-All was not law, but given its simplicity, could be accomplished in far less and result in massive savings for taxpayers and businesses currently unfairly burdened with the selection and provision of healthcare to their employees.

Our federal tax code alone has grown to encompass roughly 70,000 pages. The original in 1913, which also established the modern IRS (Lincoln created IR Secretary in 1862), was 400.

There are many more examples I would look up but I’m not paid to do this. :)

Government should be in the business of simplifying, rather than manufacturing, complexity.

A common sense approach to promoting fairness and a level playing field through sensible rules and penalties for negative economic externalities applied across our economic spectrum would create far more opportunity and unlock far greater productivity and creative inspiration than simply cutting taxes or any other form of ideological symbolism could ever hope to accomplish.

Here is one example of a simple solution that is available in the public domain:

Dodd-Frank, as mentioned above, is 2300 pages. It basically imposes a capital requirement on banks plus oversight based on whether they are deemed too big to fail and based on a complicated formula which attempts to assign a risk level by placing a risk level on each asset held. Before the financial crisis, mortgages were deemed to be virtually riskless, and mortgage derivatives weren’t even considered. The point is, the formula leaves open tremendous room for error.

The regulatory complexity has actually caused further consolidation as community banks which didn’t contribute to the crisis through leverage and speculation don’t have the resources to keep up with regional and national corporate banks.

Mervyn King, the former Governor of the Bank of England during the crisis, and the 15 years which preceded it, proposes a far simpler solution that could replace Dodd-Frank and several other laws with a small set of rules encompassing a few pages in his book: “The End of Alchemy: Money, Banking, and the Future of the Global Economy.”

He also offers an intriguing explanation of the root causes behind financial crisis and Great Recession, which aren’t often discussed in mainstream and have not yet been addressed to prevent the next one from happening.

1) First, he suggests the fed going from a “lender of last resort” to a “pawnbroker for all seasons”.

This means that the Fed insures banks against a “liquidity” crisis (when there is a run on banks; i.e. everybody rushes to get their money out. This includes short term loans from commercial entities).

When there is a liquidity crisis, banks are forced to call in their long term loans because they don’t just have your money laying around. This causes borrowers to default, which can trigger a “solvency” crisis in the borrower (like a business or a mortgage borrower).

If there are other issues, like the over-leverage (borrowing) of banks themselves and over-exposure to mortgages from synthetic “derivatives”, it can cause the bank itself to fail. Then people don’t get paid on time, and the financial system breaks down, causing a depression. This is what almost happened in 2008.

The way the Fed would provide this liquidity insurance is by requiring banks to put up collateral against their deposits in exchange for a loan from the Fed to cover their deposits during a run. So depositors will be guaranteed to get their money at the ATM, thus there won’t be a run because they know their money is safe.

Even more clever, the Fed puts a “haircut” on the value of the asset being put up by the bank as collateral. If it is a suprime mortgage backed security, the Fed can say, “I put a 100% haircut on that asset”. Meaning it is worthless because it is just too complicated and risky. Remember this putting up of collateral is happening during a calm time, not in the pressure cooker of a crisis.

By putting a haircut on the price of assets the bank puts up, it forces the bank itself to hold higher quality assets to cover its deposits, making the banking system safer and more transparent. Furthermore, the Fed will be conservative in valuing assets. So it is very unlikely to lose taxpayer money when it sells them after the crisis has passed.

Banks can be phased into this liquidity insurance program over time.

Instead of the capital ratio and ridiculously complicated, poor curve fitting, hopelessly past data dependent, single risk formula, you have the liquidity ratio:

(total liquid liabilities; i.e. deposits and short term loans) — (total liquid assets; i.e. bank money parked at Fed plus collateral they put up)

divided by total bank balance sheet.

One ratio.

2) Second, he proposes, when banks fail because of mismanagement in general, bankruptcy can transfer the depositors to a new bank, thus the system itself is not hurt by the bankruptcy. The Fed can even give them their money directly, as it has claimed the collateral from the failed bank. Payment responsibilities are handled by Fed then transferred to new bank.

3) Put a cap on bank leverage. The reason 4% of defaults in total mortgage market brought down total system of money and banking is because banks were levered 40 to 50 times their equity, or more, and a lot of it was bets with hedge funds and each other placed on mortgages and mortgage backed securities while for profit rating agencies mis-evaluated (and misreported to the Fed! Thus Fed needs to use independent non-profit ratings agencies and direct internal hires to objectively price collateral).

Imagine if you borrowed 50 times your household cash and gambled it away. That’s what these venerable big banks did.

So, King suggests putting a much lower cap on leverage, like 5 times.

In conclusion, one ratio, one rule, and a bankruptcy process can replace 2300 pages of confusing and ultimately questionable (in terms of its formula integrity) regulatory morass.

Just one example of a simple fix suggestion that is in the public domain………..

Here is an example:

Dodd-Frank, as mentioned above, is 2300 pages. It basically imposes a capital requirement on banks plus oversight based on whether they are deemed too big to fail and based on a complicated formula which attempts to assign a risk level by placing a risk level on each asset held. Before the financial crisis, mortgages were deemed to be virtually riskless, and mortgage derivatives weren’t even considered. The point is, the formula leaves open tremendous room for error.

The regulatory complexity has actually caused further consolidation as community banks which didn’t contribute to the crisis through leverage and speculation don’t have the resources to keep up with regional and national corporate banks.

Mervyn King, the former Governor of the Bank of England during the crisis, and the 15 years which preceded it, proposes a far simpler solution that could replace Dodd-Frank and several other laws with a small set of rules encompassing a few pages in his book: “The End of Alchemy: Money, Banking, and the Future of the Global Economy.”

He also offers an intriguing explanation of the root causes behind financial crisis and Great Recession, which aren’t often discussed in mainstream and have not yet been addressed to prevent the next one from happening.

1) First, he suggests the fed going from a “lender of last resort” to a “pawnbroker for all seasons”.

This means that the Fed insures banks against a “liquidity” crisis (when there is a run on banks; i.e. everybody rushes to get their money out. This includes short term loans from commercial entities).

When there is a liquidity crisis, banks are forced to call in their long term loans because they don’t just have your money laying around. This causes borrowers to default, which can trigger a “solvency” crisis in the borrower (like a business or a mortgage borrower).

If there are other issues, like the over-leverage (borrowing) of banks themselves and over-exposure to mortgages from synthetic “derivatives”, it can cause the bank itself to fail. Then people don’t get paid on time, and the financial system breaks down, causing a depression. This is what almost happened in 2008.

The way the Fed would provide this liquidity insurance is by requiring banks to put up collateral against their deposits in exchange for a loan from the Fed to cover their deposits during a run. So depositors will be guaranteed to get their money at the ATM, thus there won’t be a run because they know their money is safe.

Even more clever, the Fed puts a “haircut” on the value of the asset being put up by the bank as collateral. If it is a suprime mortgage backed security, the Fed can say, “I put a 100% haircut on that asset”. Meaning it is worthless because it is just too complicated and risky. Remember this putting up of collateral is happening during a calm time, not in the pressure cooker of a crisis.

By putting a haircut on the price of assets the bank puts up, it forces the bank itself to hold higher quality assets to cover its deposits, making the banking system safer and more transparent. Furthermore, the Fed will be conservative in valuing assets. So it is very unlikely to lose taxpayer money when it sells them after the crisis has passed.

Banks can be phased into this liquidity insurance program over time.

Instead of the capital ratio and ridiculously complicated, poor curve fitting, hopelessly past data dependent, single risk formula, you have the liquidity ratio:

(total liquid liabilities; i.e. deposits and short term loans) — (total liquid assets; i.e. bank money parked at Fed plus collateral they put up)

divided by total bank balance sheet.

One ratio.

2) Second, he proposes, when banks fail because of mismanagement in general, bankruptcy can transfer the depositors to a new bank, thus the system itself is not hurt by the bankruptcy. The Fed can even give them their money directly, as it has claimed the collateral from the failed bank. Payment responsibilities are handled by Fed then transferred to new bank.

3) Put a cap on bank leverage. The reason 4% of defaults in total mortgage market brought down total system of money and banking is because banks were levered 40 to 50 times their equity, or more, and a lot of it was bets with hedge funds and each other placed on mortgages and mortgage backed securities while for profit rating agencies mis-evaluated (and misreported to the Fed! Thus Fed needs to use independent non-profit ratings agencies and direct internal hires to objectively price collateral).

Imagine if you borrowed 50 times your household cash and gambled it away. That’s what these venerable big banks did.

So, King suggests putting a much lower cap on leverage, like 5 times.

In conclusion, one ratio, one rule, and a bankruptcy process can replace 2300 pages of confusing and ultimately questionable (in terms of its formula integrity) regulatory morass.