This is how we should regulate the Wall Street banks

President Trump has promised to dismantle much of the regulation slowing Wall Street due to his predecessor’s noted legislation, the Dodd-Frank Act. But is this deregulation necessary? Just how far can the deregulation go before we allow Wall Street banks to recreate the setting that led to the financial crisis of 2008?

The issue behind banking regulation is that there are two polar opposite stances, yet each stance’s core argument is an idea that many people can support. Those who are in favor of banking regulation mainly argue that it is a means of keeping bankers and their greedy tendencies in check in order to thwart another financial crisis. Those who are against banking regulation mainly argue that it is a burden on economic growth and an example of government overreach into one of America’s wealthiest industries. Now, what if policymakers could effectively regulate the oversight of banks all while still allowing banks to generate substantial wealth for the economy? This would be the best of both worlds. That is what this proposal aims to do. The proposal is to regulate the leverage ratio on assets to capital, create a federal rating agency, grant the power to appoint regulators to Federal Reserve, and repeal the Volcker Rule. In doing these four actions, U.S. policymakers will have effectively regulated the mega-banks to elude any possibility of another financial crisis and not reduced wealth-generating investment.

The proposal is to regulate the leverage ratio on assets to capital, create a federal rating agency, grant the power to appoint regulators to Federal Reserve, and repeal the Volcker Rule. In doing these four actions, U.S. policymakers will have effectively regulated the mega-banks to elude any possibility of another financial crisis and not reduced wealth-generating investment.

Regulated Leverage Ratio Ceiling

A major problem that is practiced by mega-banks in the United States is over-leveraging. In the 2008 financial crisis, Lehman Brothers were exposed for their inconceivable amount of over-leveraging which eventually led to their bankruptcy. Lehman Brothers continuously borrowed money for the purpose of investing in mortgage-backed securities, and once these assets became worthless after many mortgages defaulted, Lehman Brothers were left with a balance sheet soaked in red ink.

The best way to prevent another Lehman Brothers scenario is for the United States to take a page out of the banking regulation playbook from their neighbour to the north. Canadian financial institutions leverage ratios are capped at 18:1, whereas there is no cap for leverage ratio for U.S. financial institutions. Some institutions operate with a ratio over 25:1. This is utterly too high. Given that the United States is wealthier than Canada, it is proposed that U.S. policymakers regulate the leverage ratio ceiling to 20:1.

Of the eight commonly known megabanks in the U.S.—Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street, and Wells Fargo—only three are currently operating with a leverage ratio higher than the one proposed. This means that imposing a ceiling would have no burden on certain institutions, meanwhile, others would be forced to become less risky and join the other institutions in keeping their leverage ratios below 20:1. The riskiest bank, Goldman Sachs (23:1), would be forced to become less risky, less prone to fail, and strictly limited the level of debt it uses on its assets. The 20:1 leverage ratio regulation will make megabanks less risky and since many U.S. megabanks already operate below this ratio, only

The riskiest bank, Goldman Sachs (23:1), would be forced to become less risky, less prone to fail, and strictly limited the level of debt it uses on its assets. The 20:1 leverage ratio regulation will make megabanks less risky and since many U.S. megabanks already operate below this ratio, only a few megabanks will have to change the way they operate. This means that economic growth will not be substantially hindered and American savers and borrowers can confidently go to banks that do not pose a large risk to the individual and economy as a whole.

Create a Federal Rating Agency

A prominent aspect of the 2008 financial crisis that is often overlooked is the terrible job the “Big Three” rating agencies did of rating subprime mortgage bonds in order to make them more marketable and increase the earnings of the mega-banks. The “Big Three”—Moody’s, Standard and Poor’s, and Fitch Group—continuously gave very high ratings to packages of subprime mortgage bonds that were stuffed with very risky loans given to poorly accredited borrowers. The basic rationale behind this was that the housing market was so strong and steady that the strongest mortgages would absorb any losses if the riskiest mortgages defaulted, hence maintaining the value of the bonds.

The only problem was that once all of the strong mortgages had been packaged into a mortgage-backed security, there were only subprime mortgages left to put into bonds. The rating agencies gave triple-A ratings to subprime mortgage bonds and this made the bonds very attractive for mega-banks investors, yet unbeknownst to them, these loans within the bonds were doomed to fail.

According to the Financial Crisis Inquiry Report presented to Congress in 2010, the “crisis could not have happened without the rating agencies.” The report states that investors often blindly relied on them in decision-making and since there are only three in the industry, they were obligated to trust their ratings. Having for-profit rating agencies that were solely concerned with making profits caused the ratings agencies to become greedy and produce ratings that were inadequate. In order to force the “Big Three” into always producing true ratings and provide investors with a reliable rating agency to fall back on if they believe the Big Three is undependable, it is proposed that a federal rating agency be created within the Securities and Exchange Commission (SEC).

The SEC is currently funded by the American taxpayer and in the amount of $1,683,293,000. This funding is split among five divisions: corporation finance, trading and markets, investment management, enforcement, and economic and risk analysis. The SEC needs another division and it should be focused on ratings of stocks, bonds, and other commodities. The primary concern of creating a new federal agency is how much it will be funded. The divisions of the SEC are, on average, funded at about $75,000,000. By taking this average and dividing it by the amount of taxpayers filing in 2017, which is approximately 130 million, it can be deduced that adding another agency would end up costing all taxpayers an extra 50 cents. However, the benefits of this 50 cent increase in taxes are substantial. With the federal rating agency, the problem that was inadequate ratings from the “Big Three” are no longer and this can directly aid in preventing another disastrous financial crisis. Investors would be very much for this agency since it would offer them an incredibly reliable entity from which to get ratings and at a much cheaper cost. The Big Three will certainly be able to provide more in-depth ratings given they will be able to spend more, but the federal

With the federal rating agency, the problem that was inadequate ratings from the “Big Three” are no longer and this can directly aid in preventing another disastrous financial crisis. Investors would be very much for this agency since it would offer them an incredibly reliable entity from which to get ratings and at a much cheaper cost. The Big Three will certainly be able to provide more in-depth ratings given they will be able to spend more, but the federal rating agency will be required to provide the truest ratings to investors and bankers. This agency will successfully prevent another rating dilemma which subsequently played a huge role in the 2008 financial crisis. The agency will also promote the economic growth of the mega-banks as they can now cut the costs they previously allocated towards ratings by the Big Three, and instead pay for the services of the most reliable rating agency: a federal rating agency.

Grant Power to Appoint Regulators to Federal Reserve

With the growing political polarization in the United States, sole concern for political power and dismantling the opposition’s policies are becoming the theme of public office. The theme for public office should be governing well and debating ideas that benefit the citizens. This has not been the case for the past few presidential administrations and it has evidently taken a toll on our social and economic policymaking. For example, today many Americans are on edge as the newly elected Republican Congress and Donald Trump aim to repeal the Affordable Care Act, a policy championed by Democrats and Barack Obama. This uncertainty and anxiety will likely plague Americans until Republicans forcibly push their own version of healthcare through Congress and the cycle will continue once Democrats regain office.

This politicizing of issues and policies is currently a detriment to the United States. With the election of Donald Trump, it has become worse especially in the realm of banking regulation. It is very likely that the Dodd-Frank Act will not be repealed nor replaced during Trump’s term, but Trump has the ability to manipulate the rules of the law and appoint regulators that he deems fit (and share his views on banking regulation). Trump recently appointed J. Christopher Giancarlo “to oversee a lucrative corner of Wall Street [Commodity Futures Trading] that helped unleash the financial crisis.” Mr. Giancarlo has “embraced the broad goals” of Trump’s deregulatory agenda and he will be able to fulfil those goals through rule manipulation. This back-and-forth of appointing people who share policy views and firing those who oppose creates constant change within essential government organisations, and that is harmful to its productivity. In the realm of banking regulation, the power to appoint people to key regulatory positions should be with the independent Federal Reserve Board of Governors and not the politically-motivated President.

Granted the President does appoint governors to the Board of Governors, yet once they assume the office, governors are sworn to be independent of political influence and concerned with the two main goals of the Federal Reserve which are economic and financial stability. This independence from political influences make governors the perfect candidates to appoint key regulators for the purpose of maintaining economic and financial stability, rather than the purpose of scoring political policy points. This means no more manipulating the rules for politics, no more appointing people who are in favor of the political party’s objectives, and no more politicizing banking regulation. The primary goal of this proposition is to have an independent body appointing independent people to oversee crucial aspects of the banking industry which failed Americans in 2008. In doing this, the mega-banks will be independently overseen, making their oversight even more credible and without political biases. This will also promote economic growth as the politically unmotivated regulators will be primarily concerned with economic and financial stability and the financial well-being of mega-banks rather than political incentives.

Repeal Volcker Rule

In order to create more wealth, an individual may elect to invest his or her money into stocks or bonds. Investors must be smart when investing their money or they could lose a substantial amount which is clearly not in their best interest. Prior to the enactment of Dodd-Frank, banks were allowed to invest in stocks, bonds, commodities, currencies, and the like with their own assets and capital in order to increase profits and efficiently manage risk. This is known as proprietary trading. When the Dodd-Frank law was set into place, the Volcker Rule, named after former Federal Reserve chairman Paul Volcker, disallowed banks from engaging in proprietary trading.

The Volcker Rule has cost banks an estimated $4.3 billion, with much of those banks having assets worth more than $10 billion. This loss in possible profits is hindering economic growth of the banks themselves and the American economy. By repealing the Volcker Rule and allowing proprietary trading, banks will have the incentive to generate more profits through intelligent investing and be able to manage risk as efficiently as they did before the rule took place. Since the rule went into effect, the market value of bank investments “has dropped by 5.5%” and many banks activities are being forced into the “shadow banking system” due to the overly complicated regulation. Granted the repealing of the Volcker Rule will again allow the risky practice of proprietary trading, there is an opportunity for high reward and an incentive to invest intelligently because if somebody does not, this could lead to a bank losing money and in turn, that somebody loses their job.

The removal of the Volcker Rule from the Dodd-Frank Act encourages economic growth for the banks as they now can earn more profits by investing their own assets. There would be a strict restriction on what assets can be invested which means the bank will not be able to invest with federally-insured deposited money. However, all other capital and assets are fair game. The investors within the bank will have the incentive to invest well for the bank because if they do not, then they will be out of a job. Also, if the bank disregards the poor investments, keeps the poor investor, and eventually goes under because of its losses, that is the markets way of telling consumers to not trust this bank with their money. That is how an economy grows, innovates, and becomes better for everyone. With the amount of regulators in place now due to Dodd-Frank, it is almost certain that any shady trades will not go unnoticed and the American consumer and banker will be safe from another financial collapse.

Under the current banking regulations, mega-banks are overly regulated and as a result, economic growth has been slow as Americans are still recovering from the economic effects of the mega-banks’ actions. The Dodd-Frank Act has done a tremendous job in regulated the aspects of the banking industry that led to the financial crisis, but has overstepped its purpose with some regulations. In order to see more successful economic growth and wealth generated from these mega-banks, the proposal outlined in this paper should become effective immediately. A regulated leverage ratio ceiling will deter over-leveraging and will inherently make mega-banks less risky and less likely to fail.

The creation of a federal ratings agency will give investors a reliable source of information and an alternate to for-profit monopolistic ratings agencies that are misleading led to a financial crisis. The granting of power to appoint key regulators to the Federal Reserve rather than the President will take politics out of an important policy area. Finally, repealing the Volcker Rule will allow mega-banks to intellectually invest in growing their profits and will force bankers to make good decisions. Through these measures, U.S. policymakers can ensure the mega-banks are upholding their generation of wealth and doing it in a safe manner.

The financial crisis in 2008 was a terrible event that negatively affected many, but it exposed an industry that was in desperate need of reform and regulation. The crisis informed many of the immense freedom the banking industry had and how bankers took advantage of that freedom. This proposal enlightens the burdens of the Dodd-Frank Act and current bank regulations and improves them with a policy that will benefit bankers, borrowers, and the entire American economy.