A Financial Reform Perspective

http://knowledge.wharton.upenn.edu/article.cfm?articleid=2516

Whether or not we accept that the Wharton School @ UPENN is the best business school (if it's not number 1, it's usually in the Top 3), there is no question that it has the best Finance faculty in the world. We have attached the current K@W summary of how the Wharton faculty sees the House and Senate financial reform bills evolving.

Overall, we would agree with Susan Wachter that the compromise bill is not, ultimately, a "game changer" in terms of preventing a crisis. As she says, "a lot is left to the discretion of regulators." Isn't that where we were before? Again, to quote Wachter, "... it is not certain regulators would spot a brewing crisis in time or have the political will to deal with it."

Or, as Michael Blume puts it, "Had the reforms most likely to be implemented, such as centralized trading of derivatives, been in place years ago, the recent financial crisis would have been minimized ... the real issue is: how do you regulate what we don't yet know is going to happen?"

Wachter, Blume and other Wharton faculty say the House and Senate measures could have been much worse and much better. Under the provisions most likely to emerge from the House and Senate conferences are new systems for spotting risk before it mushrooms, and for shutting down financial institutions before the need for taxpayer bailouts. The derivative situation will become more transparent but, perhaps, not optimally. There will be stricter standards for credit rating agencies but we're not sure if they will be strict enough. Last, and quoting K@W, "There also will be some form of national consumer protection agency." We're not sure Elizabeth Warren will be real excited about "some form of" consumer protection agency.

Among the Wharton faculty, the most popular reform is the move to centralize the trading of derivatives, including hard-to-value mortgage-backed securities.

The bad news is that the Wharton faculty worries that the reform bills fail to resolve the problems inherent in credit-default swaps: so speculators can still bet on the ups and downs of securities they don't own (does AIG come to mind?).

The "Volcker Rule" has survived all of the compromising that inevitably goes on and that's a good thing. Generally, it would bar Wall Street firms from trading in their own accounts. The Senate bill takes a tougher stance on barring speculative trading, while the House bill would give the oversight council power to prohibit such trades if it finds they threaten the system.

Last, Richard Marston points out that the final bill will not make a lot of progress on how we get to good regulation. As he says, it's hard to legislate regulatory vigilance. Alan Greenspan was, by all accounts, the best Fed Chairman ever, and he was asleep at the switch.

Whatever the final bill, we will be real ineterested in what Elizabeth Warren's opinion is of it. We will be listening for that.