Academic

This is a bit of an outsource post, but the Committee on Capital Markets Regulation has offered its views on how the House and Senate reform bills ought to be reconciled, and its lucid analysis gives you a good sense of the sticking points.  Meanwhile the Squam Lake Group is about to come out with its report on ideal financial regulation - the group is 15 of the fanciest economists you could care to name, and, say what you like about the penetrability of AER and QJE, one thing that financial economists do pretty well pretty often is to develop an "in English" component to their work.  And that's what Squam Lake is trying to do.

Here's the CCMR bullets:

? Emergency Measures: The House bill is favored over the Senate?s because it provides more independence of the Fed and does not require advance court approval for appointing the FDIC as receiver?which preserves the regulatory ability to act quickly and decisively in an emergency.? But the Committee ?opposes both bills? proposed modifications to the treatment of secured creditors during liquidation of systemically important financial firms.?
? Credit Ratings Agencies: The Committee favors the provision of the House bill abolishing ratings agencies? exclusive exemption from Regulation FD, and the ?automatic government reliance? on their ratings, since these steps would allow the market to play a broader role in evaluating the risk of various credit instruments. However it opposes the Senate bill?s provision of lower pleading standards for plaintiffs
suing the ratings agencies and the House bill?s adoption of a tougher liability rule (it believes these agencies ?should be subject to the same liability standards as other participants in the capital markets?). It also opposes an amendment to the Senate bill giving a new Board the power ?to randomly assign issuers to ratings agencies.?
? Consumer Protection Agency: The Committee favors the House bill establishing an independent consumer protection agency, calling it ?preferable to the Senate approach of placing this function in the Fed, the only purpose of which is to give the Bureau a claim on Fed profits.?
? ?Systemically Important? Labels: The Committee "favors eliminating the moral hazard and competitive distortions that will arise from branding banking organizations as systemically important? and so it ?favors the Senate approach of giving the Fed jurisdiction over banking institutions with $50 billion or more in assets (currently 36) rather than the House approach of giving the Fed jurisdiction over ?systemically important banks?.? However, it opposes the Senate bill?s amendment applying bank capital requirements to systemically important nonbank financial institutions, which the Committee notes ?raise different types of risks.?
? Blanket Bans of Business Activities: The Committee ?is concerned about the provisions in the Senate bill that provide for a blanket ban on proprietary trading and sponsoring hedge or private equity funds? and ?prefers the House bill approach, which vests the necessary discretion in regulators to curtail a broader set of bank activities on a case by case basis.?
? Derivatives: The Committee ?opposes the Lincoln Amendment to the Senate bill that would prohibit swaps entities from borrowing from the Federal Reserve or benefiting from FDIC guarantees during a crisis? because it ?effectively prohibits banks from hedging their risks through using derivatives, and is inconsistent with other parts of the Senate bill.?

And here's some Squam Lake recommendations:

Credit Default Swaps, Clearinghouses, and Exchanges

Credit default swaps (CDS) are contracts that provide protection against the risk of default by borrowers. The failure of one important participant in the CDS market can destabilize the financial system by inflicting significant losses on many trading partners simultaneously. A clearinghouse could in theory reduce counterparty risk by standing between the buyer and seller of protection, insulating the counterparties? exposure to each other?s default. This Working Paper analyzes the market for credit default swaps and makes specific recommendations about appropriate roles for clearinghouses and about how they should be organized.

A Systemic Regulator for Financial Markets

Financial regulations in almost all countries are designed to ensure the soundness of individual institutions, principally commercial banks, against the risk of loss on their assets. This focus on individual firms ignores critical interactions between institutions. Attempts by individual banks to remain solvent in a crisis, for example, can undermine the stability of the system as a whole. The focus on individual institutions can also cause regulators to overlook important changes in the overall financial system. The solution to this narrow institutional focus is simple: One regulatory organization in each country should be responsible for overseeing the health and stability of the overall financial system. We argue that the central bank should be charged with this important new responsibility.

An Expedited Resolution Mechanism for Distressed Financial Firms: Regulatory Hybrid Securities

We recommend support for a new regulatory hybrid security that will expedite the recapitalization of distressed financial companies. The new instrument resembles long-term debt in normal times, but converts to equity when the financial system and the issuing bank under financial stress. The regulatory hybrid security we envision would be transparent, less costly to taxpayers, and more effective than the ad hoc measures taken in the current crisis.

Reforming Capital Requirements for Financial Institutions

We argue that regulators should consider systemic effects when setting bank capital requirements. Everything else the same, capital requirements should be proportionately higher for larger banks, banks that hold more illiquid assets, and banks that finance more of their operations with short-term debt. But capital requirements are not free. When designing capital requirements that address systemic concerns, regulators must weigh the costs such requirements impose on banks during good times against the benefit of having more capital in the financial system when a crisis strikes.

Regulation of Executive Compensation in Financial Services

Many people argue that inappropriate compensation policies in financial companies contributed to the global financial crisis. Some say the overall level of pay was too high. Others criticize the structure of pay, claiming that contracts for CEOs, traders, and other professionals induced them to pursue excessively risky and short-term strategies. This Working Paper argues that governments should generally not regulate the level of executive compensation at financial firms. Instead, a fraction of compensation should be held back for several years to reduce employees? incentives to take excessive risk.

Improving Resolution Options for Systemically Relevant Financial Institutions

There are critical holes in the existing regulatory framework for handling large complex financial institutions that become impaired. We endorse legislation that would give authorities the necessary powers to effect an orderly resolution. As part of this authority, every large complex financial institution should be required to create its own rapid resolution plans, which would be subject to periodic regulatory scrutiny. These ?living wills? would help authorities anticipate and address the difficulties that might arise in a resolution.