Policy Recommendations for Wall Street

Policy Recommendations for Wall Street Reform The economic crisis that this country has experienced these past two years has wrought significant economic hardship upon our nation. The roots causes of this crisis were surprisingly simple. The President, along with his economic advisers, has created a plan to address some of these root causes at the legislative level. The proposals for Wall Street reform target the corporate structures that led to the financial meltdown.

These proposals also seek to set America up for a future where these types of meltdowns are no longer possible. The first of the reform initiatives is to increase the capital and liquidity requirements for all financial firms. A second set of reforms specifically addresses the asset-backed securities at the heart of this crisis. The third part of the reform is to improve the regulatory regime for financial institutions. The fourth part of the reform is to improve the process by which financial companies are liquidated.

The first reform will require financial companies to hold more of their capital. This will help to buffer them against financial crises, putting fewer of them at risk in the event of such a downturn in future. The special requirements for the largest financial firms will reduce the risk of government bailout of these "too big to fail" firms. The downside of increasing capital and reserve requirements is that banks will then be able to lend out less of their money.

This will cut into their profits, and will make credit more difficult to come by. Given that credit remains scarce, this could potentially have negative impacts on the economy. The second component to the reforms is to increase regulation of derivatives. This includes tightening regulation of the OTC derivatives sector, increasing reporting requirements for derivatives issuers and forcing the sponsor or broker of a derivative to maintain a financial interest in the product.

These reforms could potentially stifle innovation in the industry, but in light of collateralized debt obligations, stifling innovation may be a desirable outcome. Increasing regulation is necessary, however. As OTC derivatives become more mainstream, their owners will no longer be sophisticated investors. Thus, these securities should be subject to the same regulation as other security classes.

The industry will not like this increased regulation, as it has been a source of profit in recent years, but the lack of oversight of these products specifically led to their popularization and the attendant financial catastrophe. Improving consumer protection is a less vital factor in the reform package. It focuses on ancillary issues such as predatory lending and credit card interest. Improving protections may help to reduce the incidence of consumer bankruptcy, but has two negative consequences.

The first is that the illusion of protection can encourage increased risk-taking behavior among consumers. The second is that increasing consumer protection fails to address the underlying issue, which is the atrocious level of financial literacy among the general population. These reforms, therefore, may not be effective. The fourth set of reforms addresses the ability of government to respond to the crisis. The Federal Reserve's involvement in stabilizing the financial industry may have been needed at the time, but is inappropriate in the context of the Fed's tradition role.

Furthermore, the FDIC has been forced into desperate action as its reserves have run low in the face of 100+ bank failures this year alone. The specifics of this reform have yet to be revealed. It is intended to provide a third option to bailout and collapse. Anything that prevents further bailouts should be considered good. These reforms are not without political fallout. Wall Street is opposed to the majority of these reforms. However, the industry understands that some punishment is coming in the wake of the recession.

They support Obama and Congress, but are unlikely to withdraw their support.