The Phony Wall Street Fix

Over 200 lobbyists and hundred's of million dollars have done their job. The Republicans defeated a bill to regulate Wall Street's crooks.

It was a very complicated bill that did a lot to establish even more intrusion of government into private business. The past fifty years is great evidence that regulation doesn't work very well (see the SEC and Bernie Madoff). So what is to be done?

Actually, it is quite simple. Consider this; all of the problems we have just lived through have been caused by leverage, e.g., that is the Wall Street term for borrowing money. Because big banks can borrow huge amounts of money, if one of them goes broke because of their lousy management, a huge amount of money goes out of the financial system.

But banks are required to hold back some "assets" to cover possible losses on the investments they made and paid for with borrowed money. The fundamental problem has been (and still is) that banks were only required to with hold only a tiny amount of money to cover their huge bets financed with borrowed money. Some big banks borrowed as much as forty times (40)the amount of money they kept as "reserves".

So here is how we solve the financial problem without government regulators meddling very much.

We create a set of bank sizes measured by assets. As banks grow larger with increasing assets, the reserves they must keep on their books also increase.

For example, JPMorganChase, Bank of America and Wells Fargo now hold a full 30% of all U.S. banking assets. Suppose we make them hold 25% of their assets to cover loans they have made already. The next smallest tier would have to hold 20%, the next 15%, etc. That is compared to 5% (or less now).

First thing this solves is the Too Big Too Fail problem. If the management allows the bank to grow into a higher tier, they automatically become less of a threat to the overall economy. Actually, managements will most likely manage their businesses not to grow larger since higher reserves limit their profitability.

All the government has to watch is manipulation of the definition of assets. Now that is not a minor problem, e.g., see how Lehman Brothers managed their phony assets, but it should be manageable if the government is ever going to be serious about managing Wall Street excesses.

This rule would cover commercial banks, investment banks and hedge funds. Thus, the "shadow" banking system gets regulated.

The first thing you can expect is that existing big banks will set up new banks, overseas for instance, in which they will hold substantial ownership positions. That's O.K. since each new bank will be subject to the same rules and none of them can get so big they risk the whole U.S. economic system.

Occam said it best centuries ago, "The simplest explanation is usually the best one."