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Simon Johnson: Policymakers Fear Banking Reform

By Michael Kling   |   Tuesday, 30 Jul 2013 07:59 AM

It's now three years since Congress passed the Dodd-Frank Act to reform financial services following the devastating financial crisis. But few new regulations have been implemented, Simon Johnson, a professor at MIT, writes in an article for Project Syndicate.

Rules on derivatives, money market funds and bank proprietary trading have yet to be created, writes Johnson, a former International Monetary Fund chief economist. Large banks are even larger and they continue incentives that encourage excessive risk taking.

What went wrong?

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Some say financial reform is too complicated to move quickly. Yet, "some of the world’s smartest people work in the relevant regulatory agencies. They are more than capable of writing and enforcing rules — that is, when this is what they are really asked to do," Johnson explains.

Some say conflicts between agencies, both within the United States and across national borders, have slowed progress. Perhaps, but agencies have managed to cooperate on complex issues, he maintains.

No, Johnson says, the real reason is fear. "In both the U.S. and Europe, government leaders are gripped by one overriding fear: that their economies will slip back into recession — or worse."

Big banks play on this fear, saying financial reform will make them unprofitable, hinder their lending ability or prompt other dire consequence, Johnson argues. "There has been a veritable avalanche of lobbying on this point, which has resulted in top officials moving slowly, for fear of damaging the economy."

That's a "grave mistake," he warns. Larger capital requirements would make banks safer by allowing them to absorb greater losses. The banks' claim that higher capital requirements would increase the cost of credit is false. They reported huge profits the last quarter.

Although U.S. banks are in a better position than they were before the crisis, we should still worry about them blowing themselves up, he cautions. That's why we need it put in place new regulations.

But many European banks, with less equity than their U.S. counterparts, need to increase capital cushions if they are to support a European recovery and protect themselves from losses. Unfortunately, European policymakers don't seem to understand that.

"They are wary of rocking the financial boat, so they go easy on financial reform and refuse to insist on more equity capital for banks," Johnson writes. "This is a mistake that they — and possibly all of us — may come to regret."

Speaking at CNBC's Delivering Alpha conference last week, Treasury Secretary Jack Lew criticized efforts to block new regulations. Lew compared complaints about Dodd-Frank to warnings in 1934 that creation of the Securities and Exchange Commission would "destroy our securities markets." That didn't happen.

"And today, at least some of the alarmist thinking about Dodd-Frank has faded," he said, according to his prepared text. "There is now a consensus building that completing financial reform is necessary."

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