They’ve Got It: Fixes for the Financial System
By SEWELL CHAN and BINYAMIN APPELBAUM
Published: April 23, 2010
WASHINGTON — Congress is consumed by the proposed legislation to overhaul the financial system, with lawmakers clashing over the best ways to regulate derivatives, protect consumers and end taxpayer-supported bailouts.
Most proposals in the Senate bill supported by President Obama amount to variations on the current system of regulation.
But some scholars in finance, law and economics — perhaps less inhibited by practical considerations — see an opportunity to revolutionize the financial system. In books, papers and presentations, they have proposed an avalanche of ideas, some more outlandish than others. Here are a half-dozen; judge the merits for yourself.
End the Dollar’s Supremacy
JOSEPH E. STIGLITZ
The housing bubble was inflated with vast sums borrowed from the rest of the world. Joseph E. Stiglitz, a Nobel-winning economist at Columbia, says the United States should surrender some of its borrowing power by trying to end the use of the dollar as the primary international reserve currency.
The United States basically borrows money by printing dollars and selling them, in the form of Treasury securities, to China and other governments that hold those dollars in their financial reserves. The United States then uses the borrowed money to buy foreign goods. This system, Mr. Stiglitz says, has, in effect, made the United States the world’s largest recipient of foreign aid.
The inflow of foreign money also tends to create asset bubbles, such as the spike in housing prices, making the American economy much more vulnerable to disruption and crisis. If other nations no longer needed dollars, the United States would not be able to borrow money as easily. “Knowing that it would be more difficult to borrow might curb America’s profligacy,” Mr. Stiglitz writes in “Freefall: America, Free Markets and the Sinking of the World Economy” (W. W. Norton, 2010).
Give Bankruptcy a Chance
THOMAS H. JACKSON
When Lehman Brothers went to bankruptcy court in September 2008 after the government refused to rescue it, credit markets froze. The authorities quickly caved in and bailed out a bunch of other companies.
Lehman’s disorderly collapse, conventional wisdom says, showed that bankruptcy courts could not handle huge financial failures, because they were too slow, lacked the expertise and were not designed to consider the intricate linkages that hold financial companies together.
The bills in Congress seek to design a federal “resolution authority” — a way to arrange the orderly liquidation of giant financial companies — modeled after the process the Federal Deposit Insurance Corporation uses to take over failed banks.
But Thomas H. Jackson, former president of the University of Rochester, says the panic was not caused by bankruptcy proceedings, but by letting Lehman fail in the first place. Under current law, parts of Lehman went through bankruptcy, while other subsidiaries could not.
Among other changes, he calls for amending bankruptcy laws to cover companies — retail banks, stock and commodity brokers and insurance companies — so that large, complex institutions could be fully dealt with in court. And regulators would be able to pull the trigger.
“There’s a lot to be said for a judicial process rather than a government agency process,” says Mr. Jackson, author of an essay in “Ending Government Bailouts as We Know Them” (Hoover Institution, 2009). The legal system is more predictable and transparent and better established.
Bonds Can Regulate Banks, Too
ROBERT C. POZEN
Many economists say that creditors, who determine how much banks can borrow and on what terms, are often better equipped than regulators to provide the market discipline that can keep banks from taking on too much risk.
Unlike stockholders, bondholders have little to gain when banks take on risk in the hope of reward. What they want is a steady stream of income and the repayment of their loan. Corporate bonds tend to be held by institutions like mutual funds, hedge funds and insurance companies that have the time and resources to monitor their debtors.
Robert C. Pozen, chairman of MFS Investment Management and author of “Too Big to Save? How to Fix the U.S. Financial System” (Wiley, 2010), wants to require banks to issue an existing kind of bond known as long-term subordinated debt. “Subordinated debt is bought by very sophisticated investors who insist on conditions like capital requirements and covenants to make sure that banks don’t take on too much risk,” he says.
Since their investment is not guaranteed and their time horizon is long term, such creditors have interests closely aligned with those of government regulators, says Mr. Pozen, who is also a lecturer at Harvard Business School.
In a 2000 report, the Fed studied requiring banks to hold subordinated debt, but the idea went nowhere. Banks don’t like it because such debt generally charges higher interest than other kinds of corporate bonds.
Compound Interest 101
A person borrows $100 at an annual interest rate of 20 percent. How long does it take that debt to double? About four years. What share of American adults can figure that out? About one in three, says Annamaria Lusardi, an economist at Dartmouth College.
Ms. Lusardi wants to add financial literacy to high school curriculums. A crisis sparked in part by the decisions of millions of Americans to take mortgage loans they could not afford has underscored her conviction that “lack of financial knowledge is alarmingly widespread.”