Thursday, October 4, 2012

After repealing the Dodd-Frank Act, Romney would start reform of financial system with transparency

As reported by Reuters, Republican presidential candidate Mitt Romney once again pledged in his debate with President Obama to repeal the Dodd-Frank Act.

When asked what he would replace it with, he said
You have to have transparency...
Regular readers know that your humble blogger's opinion of the Dodd-Frank Act is that with the exception of the Volcker Rule and Consumer Financial Protection Bureau it should be repealed.

Why do I think the rest of Dodd-Frank should be repealed?

Because the rest of Dodd-Frank is based on the idea of using complex rules and regulations in combination with regulatory oversight as a substitute for transparency and market discipline.
"Regulation is essential. You can't have a free market work without regulation," ....
"At the same time, regulation can become excessive ... And what's happened with some of the legislation that's been passed under President Obama's term is you've seen some of the regulation become excessive...."
The essential regulation is to bring transparency back to all the opaque corners of the financial system.

For banks, this means regulation requiring them to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With this information, market participants could have exerted discipline on the banks to restrain their risk taking and limit their exposure to other banks to what they could afford to lose.

For structured finance securities, this means regulation requiring them to provide observable event based reporting under which any activity like a payment or default involving the underlying collateral is reported before the beginning of the next business day.

With this information, the size of the subprime mortgage market would have been smaller as market participants could have seen that the securities were not performing as valuation models predicted.

Obama hit back at Romney's criticisms. 
"The reason we have been in such an enormous economic crisis was prompted by reckless behavior across the board," Obama said.
Actually, the behavior was not reckless.  It simply reflected the fact that investors were underpricing risk as a result of the opacity in the financial system.

Who were the investors, who are provided with disclosure that makes banks a 'black box', to quarrel with the Federal Reserve, who has ultra transparency, when the chairman of the Fed says that banks are less risky?

In the absence of ultra transparency, investors were dependent on the regulators to both properly assess the risk of the banks and to communicate this risk.
"The question is does anybody out there think that the big problem we had is that there was too much oversight and regulation of Wall Street? .... But that's not what I believe."
I think the big problem we had is that there was too much oversight and regulation of Wall Street and not enough transparency.

Simply put, the regulators were not up to the task of replacing the market and exerting discipline on the banks.

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