Two very smart financial minds, legendary currency trader George Soros and former Secretary of Labor Robert Reich, share how they would reform the financial system. The people in charge of this momentous task would be wise to listen to what Soros and Reich propose. See the following post by Economist Mark A. Thoma from The Economist's View. First, Robert Reich:The Three Essentials of Financial Reform, by Robert Reich: As the White House unveils its long-awaited proposals to prevent another Wall Street meltdown in the future, kee...ookout for three essentials. Without them the Street will revert to its old ways as soon as the coast clears... . 1. Stop bankers from making huge, risky bets with other peoples money. At the least, require they back their bets wit...arge percentage of their own capital, and bar them from raising money off their balance sheets through derivative trades. Also require they take their pay in stock options or warrants that cant be cashed in for at least three years, so theyll tak...onger-term view. Best of all would b...equirement that investment banks return to being partnerships and the capital on their books be their own, not yours or your pension funds. When investment banks were partnerships, every partner took an active interest in what every other partner and trader was doing. The real mischief started once they started selling shares to the public. 2. Prevent any bank from becoming too big to fail. Separate commercial from investment banking... Combining the basic utility with the casino only made bankers far richer and subjected you and me to risks we didnt bargain for. If separating commercial from investment banking isnt enough to bring all banks down to reasonable size, use antitrust laws to break them up. 3. Root out three major conflicts of interest. (1) Credit-rating agencies should no longer be paid by the companies whose issues are being rated; they should be paid by those who use their ratings. (2) Institutional investors like pension funds and mutual funds should not be getting investment advice from the same banks that profit off their investments... (3) the regional Feds that are responsible for much bank oversight should no longer be headed by presidents appointed by the regions bankers; non-bankers should have the major say, and the regional presidents should have to be confirmed by the Senate... [T]he big bankers will fight every one of these with all guns blazing, and their lobbyists in full force... . Bottom line: Genuine financial reform will be almost as difficult to achieve as real universal health care. Immense private interests are amassed against the public interest in both cases because staggering amounts of money are at stake... . Second, George Soros:The three steps to financial reform, by George Soros, Commentary, Financial Times... ...m not an advocate of too much regulation... . While markets are imperfect, regulators are even more so... . Three principles should guide reform. First, since markets are bubble-prone, regulators must accept responsibility for preventing bubbles from growing too big. Alan Greenspa... . expressly refused that responsibility... . Second,... we must also control the availability of credit... , we mus... . use credit controls such as margin requirements and minimum capital requirements... . Margin and minimum capital requirements should be adjusted to suit market condition... . to forestal... . bubbles. Third, we must reconceptualise the meaning of market risk. The efficient market hypothesis postulates that markets tend towards equilibrium and deviations occur i...andom fashion... But the efficient market hypothesis is unrealistic. Markets are subject to imbalances... If too many participants are on the same side, positions cannot be liquidated without causin...iscontinuity or, worse...ollapse. In that case the authorities may have to come to the rescue. That means that there is systemic ris... . in addition to the risks most market participants perceived prior to the crisis. The securitisation of mortgages adde...ew dimension of systemic risk. Financial engineers claimed they were reducing risks through geographic diversification: in fact they were increasing them by creating an agency problem. The agents were more interested in maximising fee income than in protecting the interests of bondholders... . To aver...epetition, the agents must have skin in the game but the five per cent proposed by the administration is more symbolic than substantive... . It is probably impractical to separate investment banking from commercial banking as the US did with the Glass Steagull Act of 1933. But there has to be an internal firewall... Finally...ave strong views on the regulation of derivatives. The prevailing opinion is that they ought to be traded on regulated exchanges. That is not enough. The issuance and trading of derivatives ought to be as strictly regulated as stocks... . Custom made derivativ
