Wednesday, July 18, 2012

Should Romney Take on Banking Reform?

AEI's James Pethokoukis lays out the electoral benefits of Romney taking on banking reform:
But if Romney presented an aggressive, free-market, anti-crony capitalist, financial reform agenda — something beyond the fuzzy “Repeal Dodd-Frank and replace with streamlined, modern regulatory framework” pledge on his website — he could demonstrate he’s neither a creature of Big Money nor a Bush clone. Oh, and he would be putting forward some smart policy ideas, too.
Here’s a possible Romney financial reform agenda:
1) Endorse the Hoenig Plan. Thomas Hoenig, vice chairman of FDIC and former president of the Kansas City Fed, wants to bust up the big banks. He would only allow banks to engage in traditional activities that are well understood and are based on long-term customer relationships so borrowers and lenders are on the same page: Commercial banking, underwriting securities, and asset management services. Banks would be barred from broker-dealer activities, making markets in derivatives or securities, trading securities or derivatives for their own accounts or for customers, and sponsoring hedge funds or private equity funds.
 2. Go after high-frequency trading. Financial markets seem more volatile than ever, and one reason might be super-fast, or “high-frequency,” trading, where computers buy and sell bonds, stocks, and derivatives in milliseconds. As my friend Martin Hutchinson of the Asia Times puts it:
High-frequency trading is objectionable for two reasons. First, its proponents claim it provides liquidity to the market, but that’s not really the case. In periods of turbulence, the liquidity that HFT supplies is quickly withdrawn, as the institutions operating the trading systems shut them off for fear of large and destabilizing losses. Indeed, liquidity that switches off when it is most needed is of no use at all. To the contrary, it destabilizes the market rather than stabilizing it.
The second reason high-frequency trading is bad is that it uses machines to get trade information before competitors. Of course, trading based on extra-fast knowledge of the trading flow should qualify as inside information, and thus be illegal.
Unfortunately, it can’t be made illegal, because market-makers do it all the time. And what’s more is that stock exchanges make huge sums of money by renting space within feet of the exchanges’ computers to high-frequency traders.
Hutchinson recommends a 0.01%-0.02% Pigovian tax on trading stocks and bonds and a 0.05% tax on derivatives to tamp down on such speculation. The revenue could be used to lower the overall corporate tax rate.
3. Endorse the mortgage refinancing plan of his own economic adviser. Economist Glenn Hubbard, along with his colleague Christopher Mayer at Columbia University, has devised a plan where every homeowner with a GSE mortgage could refinance his or her mortgage with a new mortgage at a current fixed rate of 4.20% or less. Nearly $4 trillion of mortgages could be refinanced, helping roughly 30 million borrowers save $75 billion to $80 billion a year. As Hubbard and Mayer see it, it would be like a long-­lasting tax cut for these 25 or 30 million American families. ”The plan would have an immediate fixed cost to the government of $242 billion with half that cost split equally between the government and banks.”
As Pethokoukis notes, these specific proposals might not be ones that are ultimately worth going with, but they do suggest some directions that Romney's team could go in.

Some commenters at AEI have objected that, because Romney has a number of large Wall Street contributors, he will be unlikely to propose putting forward a lot of new regulations on world of finance.

However, I think there's another way of looking at it: rational, market-oriented regulatory reforms could ultimately be in the financial sector's best interest.  With Dodd-Frank doubling down on the era of Too Big to Fail and financial instability, we could be only a few market jolts away from yet another financial crisis.  And no one knows who will be the next Bear Stearns.  A few politically connected individuals gain power in the era of big bailouts, but a crash could tear down almost anyone.  And there is no guarantee of another bailout in the future, which makes the potential for loss that much greater.

Rational reforms would be a hedge against such failure.  Good reform would benefit both the financial sector and the economy as a whole.

Proposing a serious set of reforms could also, as Pethokoukis claims, be beneficial to the Romney campaign: it changes the narrative from one of personality to one of policy.  Barack Obama had his shot at financial reform; he can defend that on the campaign trail if he wants.  By speaking about the importance of real financial reform, Romney could harness popular dissatisfaction with the economic dysfunction of the present moment while also advancing conservative principles.

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