Thursday, November 13, 2014

Bank regulation proposal

  1. A bank which fails will be taken over by the FDIC regardless of size, the Federal Reserve will have the full authority to print money as needed to cover deposits. There will be no bailouts of any company.
  2. A bank which is shut down that is within one state will be handled by the Federal Reserve bank it is located in and will be bought out by other bank(s). It may only be bought out by banks which do not have interstate operations. This is to keep diversity within the financial system with lots of lending institutions.
  3. A bank which is shut down which crosses state lines will be divided by state, and be bought out by banks which do not have interstate operations. This is to insure diversity of the banking system and prevent any one bank getting too big to be a systemic risk. It will also increase the number of banks which is an essential part of a fully functional market.
  4. Banks will be allowed to form in any region based on the credentials of that one bank’s operations regardless of the other banks operating in that region. A historic problem has been restricting the growth of the banking sector which has stifled the number of banks in this country from what we can have. One key to a successful market is having lots of sellers and this will ensure that will occur.
  5. Current regulations that require banks to meet certain thresholds of reserves will continue and be more thoroughly enforced. Banks will have an extra penalty on loans they cannot collect on that will be paid into the FDIC fund.
  6. A bank must retain at least 10% of the loans they make on their books. A bank may not sell a package of mortgages or other loans without information on the creditworthiness of the people and businesses in the package. The failure to do so after a long time will make it so they must pay higher interest rates when borrowing from the Federal Reserve and will be fined proportionately to the bank's asset value.
  7. A bank must leave all of their investments on their balance sheet. If the regulator discovers a bank left investments off of its balance sheet for 3 different inspections will have its charter revoked and be treated like a failed bank. Every member of the Board of Directors, the CEO, CFO, and other people in charge of leading the bank will be charged with fraud as a felony and serve time in prison.
  8. The FDIC will have full authority to invest and use its funds as needed. There is no reason not to use these funds and have them grow to create a strong fund.
  9. Interbank lending will be fully insured up to 2% of deposits for all banks, so when one bank fails it won’t spread to other financial institutions. This is so future bank crises won't spread. They spread because banks lend to other banks, so if one bank fails and another bank has a large amount of deposits in another this creates an imbalance in the bank's balance sheet which is how banks fail. This is meant to protect well-functioning banks from a few bad apples because our economy is (and should be) highly interconnected.
  10. Stricter regulation of credit rating agencies to ensure they accurately rate financial tools. The regulator will have full authority to punish credit rating agencies when they inaccurately rate financial instruments.
This is because if we bail out banks we create a problem that they cannot lose if they make bad decisions and will then take more risk than they can handle (Economists call this moral hazard). We need to keep the managers of banking institutions accountable to their actions, and this requires that we do not bail out banks when they start to fail because it means they will be more likely to put their institutions at risk. We need to protect depositors money, while still keeping the managers of the banks responsible for their actions. Otherwise we will have more banking crises because they will take more risk than they can handle which will create a larger financial crisis.

The other problem with this is the key to a successful free market is having a lot of sellers of goods and servies, and bailing out big banks creates a concentration of power where there should be many different types of banks. This policy outline aims to create a more diverse banking sector which will benefit lenders, borrowers, and also benefit banks because there will be more options to borrow with one another which leads to a more stable financial system. Bailing out banks defeats this important piece of the economy which harms everyone when lending and borrowing freezes.

I have also omitted the major parts of Glass-Steagall legislation (restricting types of banking and where banks can be formed) because it restricted competition between banks and restricted consumer choice. It also had the negative impact of increasing the price of loans for consumers without significantly stabilizing the financial sector. No other country in the world has ever done this type of legislation, and the proposals outlined above are designed to get the stability of banking without the costs of high lending fees and lack of choice that Glass-Steagall created. It is a very simple equation in economics, if you reduce supply this will increase price and this is always bad for consumers.

To be clear, this isn't about being pro-bank or anti-bank. This about ensuring that banks have the resources they need to operate without being destructive to the financial system, and ensure that borrowers and depositors are protected. In this way this plan tries to strike a balance between policies which are pro-lender, pro-bank, pro-borrower, and pro-investor. I think I have made the proper balance for a stable financial system which will lead to a stronger economy for America and protect everyone regardless of income level of profession.

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