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Tony Cherin

Expert Insights: Regulatory reform

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Tony Cherin, Ph.D., is a professor emeritus of finance at San Diego State University. His fields of interest include banking, financial markets, financial services and investments.

What are your thoughts on the role of government regulation in your industry? How big a role should it play?

I definitely think there's a need for government regulation. There's no doubt about that. The tricky part is how much government regulation? What actually happens in these particular instances is what some refer to as "trial and error" -- but that's not the best way to explain it. There is something referred to in the literature as the regulatory dialectic, in which there are really three stages. First, the government comes in and imposes rather "onerous" regulation on the industry. That is referred to as the thesis. Under such circumstances, the industry rebels and looks for ways around the regulations. This is referred to as antithesis. The government realizes the regulations they've imposed are a little too heavy-handed; they realize the industry is finding ways of circumventing the regulations. So they sit down with the industry, talk things over and reach a consensus on regulation. This is called synthesis. So you go through this process of thesis, antithesis and synthesis, and this is what I think is in the offing in terms of government regulation. That's a short-term industry outlook on how big a role the government will play: It's about eventually reaching a consensus. The industry cannot operate in as efficient and as workable a matter as it can with over-regulation.

Tony Cherin

Is change needed? How much blame for the financial crisis would you lay on the backs of regulators?

At the moment, there's necessary "re-regulation." It's not changing all the rules, but taking a good close look at the rules and seeing what rules still make sense, what rules may not make sense, and what rules need to be imposed where there were no rules before. I'm particularly thinking about derivative markets. These markets need to be more heavily regulated than in the past. There are a lot of derivatives traded on organized markets, but a lot of derivatives are traded on over-the-counter markets, where there is very little regulation. A lot of these derivatives ended up in the portfolios of large banks, and this contributed to the current crisis. Also, if I were calling the shots, I would be looking for a renewed separation between commercial banking and investment banking. I would want to rebuild the firewall between those two activities. Today, that wall has been both de facto and now de jure torn down. Is change needed? I think change definitely is needed, particularly in the derivatives industry. Particularly, when large pools of mortgages are securitized and sold off. I think the organizations and institutions that do the securitizing need to have a stake in that pool of derivatives and not just sell them all off. That is, the securitizer needs to carry some of those derivatives (i.e., mortgage-backed securities) on its balance sheet as well.

What are your thoughts on Obama's proposed regulatory reforms? What did you like? Was there anything you didn't like?

When we see these regulations come out of the Obama administration, I don't think that's going to be the end of the story. Take as example, the idea that an institution can't be too big to fail; thus limiting its size. I don't think that will be the final story. Institutions will be able to grow big, but they're going to have to write a plan describing how they can be broken down and sold off if they do fail, which the Obama administration has alluded to. The Obama administration has said, "We don't want to have institutions that are too big to fail," but at the same time, it's sort of tongue in cheek. They're saying that if an institution gets really, really big -- and there are some institutions that have to be big -- they need to have to plan for their own destruction. If something happens to them, they have to be able to be broken into parts and be sold off. The Obama administration has already gotten to the point of synthesis on their own without talking to the institutions. They're saying, "If you do grow big, you really need to protect yourself against risk in such a manner that it won't lead to systemic risk."

Also, there seems to be some contention as to what part the Federal Reserve System should play in the regulatory environment. The Obama administration wants the Federal Reserve to be the chief regulator with a council of regulators beneath it. I am definitely in favor of putting the Federal Reserve in charge of the system. In my opinion, they're the best organization/institution to judge systemic risk. They've been dealing with the institutions in the marketplace for a significant period. The Federal Reserve is also a completely separate entity from the government. In other words, when the Federal Reserve was established in 1914, it was set up in such a fashion that they have certain reporting requirements to the legislative and executive branch, but they do not depend on Congress, the executive branch or the judicial branch for any kind of appropriation. There are no payments from Congress to run the Federal Reserve System; they pay themselves based on the return on the portfolio of securities that they carry. They're an independent agency from the rest of the government: The members of the Federal Reserve Board of Governors are selected for terms that do not coincide with the administration, so the influence of the executive branch and/or Congress can't be too heavy because they're not dependent on those agencies for re-election. For example, the current chairman of the board, Ben Bernanke, has been appointed for a 14-year term. The political influence that the administration or Congress can have over the Federal Reserve is limited, and I think that's very important.

I haven't seen all the i's dotted and the t's crossed on what's going to take place. Based the initial package, I don't see anything that rebuilds that firewall between commercial banking and investment banking. We need to revisit the Glass-Steagall Act (of 1933, which was materially changed by the Gramm-Leach-Bliley Act of 1999). That firewall needs to be there in some form or another to further ensure a separation between what investment banks can do in regard to various derivatives and securities and what commercial banks can do in regard to various derivatives and securities.


-- Compiled by Rebecca Go

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