January 30, 2017

"Reframing Financial Regulation" Reviewed by the Wall Street Journal

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A new book pitched at influencing financial regulation under in a Trump administration won't make for pleasant reading for supporters of the Dodd-Frank Act or even Wall Street bankers.

"Reframing Financial Regulation," published by the free-market Mercatus Center at George Mason University, calls for fewer, simpler regulations, including removal of the mandatory clearing of derivatives and higher minimum capital levels for banks.

Written and edited by a group of right-leaning lawyers and economists, the book says the postcrisis, "bulked-up financial regulatory structure provides a false sense of security, distorts competition and impedes capital flows." It suggests an array of changes aimed at severely limiting explicit and implicit government guarantees to financial institutions.

Co-author and editor Hester Peirce, who is expected to be nominated as a Republican Securities and Exchange Commission member next year, proposes in her chapter reversing the Dodd-Frank mandate to clear certain OTC derivatives through central counterparties. That would end the designation of CCPs as systematically important by the Financial Stability Oversight Council, and cut CCPs off from Federal Reserve liquidity safety nets.

"Despite good intentions, the Dodd-Frank framework has given rise to a new set of risks by compromising the effectiveness of clearinghouse risk management while simultaneously encouraging CCPs to embrace new risks," Ms. Peirce writes. "The growth and change of CCPs in response to government policy builds bailout expectations," she adds, saying decisions about which products should be cleared centrally should be left to the private sector.

Ms. Peirce was tapped in 2015 for an open seat at the SEC, but her nomination failed to advance through the Senate. She was also a senior adviser to former SEC commissioner Paul Atkins, a key member of Donald Trump's financial policy transition team.

The book adds to the debate about whether easing financial regulation under a Trump administration will benefit large incumbent financial institutions, which have recently argued against wholesale repeal of Dodd-Frank.

Two chapters of the book point to the benefits of dumping the prevailing system of setting banks' minimum capital ratios based on risk-weighted assets--a practice Wall Street banks have staunchly defended--in favor of simpler, higher ratios, the sort favored by FDIC Vice Chairman Thomas Hoenig.

"The key challenges are preventing capital adequacy regulations from being weakened by exemptions on assets through risk-weighting and ensuring that the definition of capital does not include sources of funding that cannot be used in a time of distress," writes Stephen Miller, a senior research fellow at the Mercatus Center.

Co-author Arnold Kling also recommends removing the bias toward debt that is built into the tax system, a proposal that reflects a Republican plan to introduce a business "cash flow tax," which would remove the deductibility of net interest expenses. "The tax laws could be changed so that beyond the first $100 million in interest expense, only 80 percent of interest expense is deductible from corporate income tax," he writes, suggesting an alternative of imposing dollar limits on the value of government-insured deposits available to any one bank.

Overall, the book decries the explosion in financial regulation before and since the financial crisis, suggesting the 2010 Dodd-Frank Act alone added a further 28,000 constraints.

"The knowledge of intelligent, well-intentioned government regulators cannot determine what financial products or services are appropriate," the editors write.