Panel Explores Financial Reforms, Initiatives

By Eric Robins
Associate
Williams & Jensen PLLC
Washington, D.C.

Ben Friedman, Harvard University professor, and Frank Hatheway, chief economist of NASDAQ OMX, spoke at a March 9 Policy Conference session on financial regulation, examining regulatory changes in the financial markets and discussing additional policy initiatives going forward in the United States, Europe, and globally.  Nayantara Hensel, chief economist of the Department of the Navy, moderated the discussion. 

Looking at lessons of the recent financial crisis, Friedman explained that how the Federal Reserve “holds money” is an unfortunate distraction, in light of how central banks set interest rates.  He noted that the Federal Reserve is quite able to change rates without too much of a change in reserves.  The Fed can raise the short interest rates without major meaningful changes in the balance sheet, but the composition of bank assets does matter.  The current pressing moment with this crisis is the mortgage market, and securities pricing can have an effect on the mortgage market, he said.

Freidman cited three lessons that bear on financial regulation: (1) neither self-regulation nor regulation by capital market creditors is effective for these complex markets; (2) the United States needs greater authority to resolve companies (i.e., there is no comparable authority for a government takeover of insurance companies and broker-dealers); and (3) there are problems of a lender of last resort with the ability to price assets.

Hatheway suggested that there is a systemic put in the system, in that when there is a financial crisis, firms turn to the government for help.  Offering some pure market approaches for dealing with this, he suggested lowering the strike price of a put (which reduces the claim) or reducing the volatility of the option (which reduces or shifts risk). 

Hatheway noted that clearing, in bringing transparency to markets, reduces systemic risk.  He suggested that this provides better surveillance, can resolve failures and better prevent the spreading of risks.  He indicated that when there are assets that are difficult to value, they should be brought into the market and into a single place.  He explained that clearinghouses allow more creditors into the market, though he acknowledged that the negative is that they are more expensive.  He suggested that if the costs were too high or low, this would not work.

Suggesting that market structure issues (e.g., IOIs, sponsored access) represented only business conduct changes, he stated that they will not impact systemic risk.  He then questioned whether the better approach to solving systemic risk was through: (1) fees, (2) taxes, or (3) reducing risk associated with the put.

Accounting Rules

As to the future of accounting rules and market practices, Friedman noted that there was a lot of conversation on capital requirements and accounting principles.  Hatheway stated that mark-to-market accounting is based upon a set of assumptions such as dynamic hedging, and that there was a need to deal with whether there was an implicit assumption here.

Monetary Policy and Borrowers

It was asserted that one of the underlying causes of the crisis is that the Fed drove rates very low and that led to a shift in home mortgages from fixed to adjustable rates (such as teaser rates and other ARMs).  Friedman suggested that if it is a problem, there is a need to deal with it where the problem lies.  He added that what is needed is to determine what impacts the mortgage borrowers’ decisions, rather than anything that impacts monetary policy.  He added that this could be addressed through tax policy or minimum down payments, without constraining monetary policy.

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