CGD senior fellow Liliana Rojas-Suarez discussed the main differences and hot button issues regarding the proposals of Democratic and Republican Senators on the Financial Regulatory Reform. Four major areas of debate were identified: the consumer protection agency, financial derivates, the roles and limitations of the banks, and the rescue fund.
She argued that the major controversy has been the rescue fund proposed by the Democrats. The proposal would involve taxing any financial institution with assets over 50 billion dollars, to create a fund that will be used in cases of systemic crises. She said that the Republican Party objected to the proposal because it validates the bailout process. In her opinion, the creation of a fund to deal with crisis resolution is much needed, although not necessarily with all the features proposed by the Democrats. She argues that without the fund, there is no way to prevent that taxpayers would have to provide rescue money in future systemic crises.
Related to this discussion, is the idea of “too big to fail” and the proposal to limit the size of financial firms. According to Liliana the real issue is not how big a financial firm is, but its level of interconnection in the system. On one hand, there has been a number of crisis episodes where small financial institutions were at the core of the problem. A case in point is the crisis of the Savings and Loans institutions in the United States in the 1980s. On the other hand, determining the point at which a firm is too big is very difficult. She argues that there should be greater focus on regulations such as capital requirements and proposes an increase in the simple, non-risk weighted leverage ratio as well as increases in capital requirements and limitations for undertaking certain financial products, which has proven to be not only excessively risky but lacking sufficient transparency. It also becomes important to define what “capital” means: capital should be defined solely as common shares; that is, shareholders’ investment in the financial firm.
Regarding the proposal for regulating derivates, Liliana commented that she has been argued for a number of years now that it is important to trade the derivate products in a regulated exchange. There is no way we will have enough information about the level of risk in the economy if these financial products are not traded in a regulated market.
The interviewer also asked her about her opinion on separating banking operations and the investment banking. Liliana thinks that, while there are merits in that proposal, it might now be too late to do this since it will lead to regulatory arbitrage.
Finally, when asked about the consumer protection agency, she said that, while independent, this regulatory body should be located at the FED. She also mentioned that this agency should ensure that consumers obtain adequate information about the different financial products that are in the market . She believes there are currently big failures in terms of consumer protection in the market.