Morningstar markets editor Jeremy Glaser says that consumer protection, 'too big to fail,' and leverage provisions are a
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Five Ideas for Financial Reform Amendments Jason Stipp: I'm Jason Stipp for Morningstar and welcome to the Friday Five. The government is turning its attention to financial reform now that the healthcare reform bill has passed about 100 amendments are being considered for this bill. And after yesterday’s bizarre market activity, a few more might be added to the docket. Morningstar's market editor Jeremy Glaser has a few ideas for reforms that he'd like to add to the bill and he's here to tell me what they are today. Jeremy thanks for joining me. Jeremy Glaser: Always a pleasure, Jason. Jason Stipp: So what are the five things that you might like to see added to the bill that aren't being considered right now? Jeremy Glaser: I think we need to talk about a consumer protection agency, this idea of "Too Big to Fail," leverage in the system, derivatives. And finally, we're going to talk about two parts of the banking system that I think really need to be separated. Jason Stipp: Consumer protection agency is possibly a contentious issue. What would you like to see specifically added on that front? Jeremy Glaser: This has been certainly one of the more contentious pieces of the legislation where Republicans seem to be pretty opposed to it, while Democrats continue to want to put a very robust consumer protection agency in that would essentially regulate a lot of the financial products that are coming out of the banks. So if you wanted to create a new type of mortgage or a new type of savings account, well maybe savings accounts aren't that contentious. But they would have to go through some sort of regulatory review process before they could be put in front of consumers. I think that this is a dual-edged sword. I think we certainly want to make sure that banks are providing consumers with all the information that they need to make informed choices about their finances. So, important provisions shouldn't be buried in the small print of a mortgage. You should know when it's going to reset and what it's going to reset to, and what the resets look like in the future. Information like that it’s really important to people. So should the government necessarily be deciding exactly what kind of things could be available to everyone? Probably not, but should they make sure that people have the information they need? Absolutely! Jason Stipp: So for number two, TBTF, it's not a yogurt; it's "Too Big to Fail." It's on everyone's lips recently. Tell us a little bit about "Too Big to Fail" and what these reforms really need to capture on that front. Jeremy Glaser: Certainly, "Too Big to Fail" is one of the big issues that need to be solved by this regulatory regime. The problem that we saw before with Lehman Brothers was that you could force a firm into bankruptcy but then the entire capital market seized up because nobody knew where any of the money is, nobody knew where those assets were, and Lehman Brothers was counterparty to so many different transactions. So, whatever this new bill does, it needs to create a system in which these firms can wipe out the equity holders, but stay operating long enough in order to wind down these trains in an orderly fashion, so that the market can actually correct for this. And that we can punish the people who took the untoward risk, but then also not worry about punishing everybody else because the entire system would completely collapse. Jason Stipp: For number three, leverage is a dirty word for a lot of people. It seemed to get some firms into trouble. What should the reforms account for on the leverage front? Jeremy Glaser: Leverage is something the federal government definitely needs to be looking at. As all the investment banks have now become bank holding companies and that means that deposits are insured by the FDIC. So the federal government is back there saying the full faith in credit of the federal government is behind these deposits. So I think that means the federal government should have a say in saying, "All right”. This is what you need to do with these deposits. You can't lever it to these extreme measures that you had before. This can be incredibly difficult to measure. Last week, we were at the University of Chicago, Booth School of Business Management Conference, and we talked about to Professor Steve Kaplan, who was talking about these issues that he thinks capital requirements would be a good way to do this to make sure the banks have more capital. That would keep the leverage down more than coming up with a firm number that would be there. But no matter how you actually keep this leverage on track, I think it's something that the bill needs to address. And something that if the banks are going to be insured by the government, the deposits are, we need to make sure that those deposits are actually being kept safe. Jason Stipp: Sure. Number four, Obama was on the news recently because of the nuclear reforms that he was making. Buffett had talked about derivatives as being "weapons of mass destruction." What kinds of reforms need to happen with derivatives? Jeremy Glaser: Derivatives can be a big issue. So there certainly are cases where derivatives serve a useful purpose. You have hedging for a lot of operating businesses that want to be able to get rid of that fuel risk or get of any risk that they're trying to look at. But at the same time, we saw that derivatives got people into trouble and just added a lot more kind of hidden leverage to the system and interconnected to the system than people saw before. So I think, at the very least, we need to have a central clearinghouse where these derivative trades are happening. So that way, we have a sense of how many of them are out there, who their counterparties are. So if we do get into a "Too Big To Fail" situation, if we do get into another crisis, we'll know exactly where the risks are and can address them, instead of now where a lot of those are just open questions. Jason Stipp: For number five, I think this maybe would might impact the consumers perhaps most directly of all your ideas. Tell us a little bit about what you think needs to be separated in the banking system. Jeremy Glaser: There have been a lot of calls to bring back Glass-Steagall, which is this idea that if you have a bank holding company, you shouldn't also be able to own other financial institutions. And this had been around since the Depression, was repealed in the '90s and there's a lot of talk that this is what caused the financial crisis. But I think what really needs to be separated is the pen from the desk. I think it's time to finally get rid of that little chain that makes it so difficult to write out those deposit slips. I think it's something that consumers will really find helpful and should get the rest of the banking system back on track. Jason Stipp: I've noticed that the pens are good for etching my name into thing but not so much for writing. Jeremy Glaser: Yeah exactly. Jason Stipp: Thanks for joining me, Jeremy. Jeremy Glaser: You're welcome, Jason. Jason Stipp: I'm Jason Stipp for Morningstar and thanks for watching.