Charles Kahn, a finance and economics professor, chairs the finance department at Illinois.
President Obama has proposed new, far-reaching regulations that would affect nearly every phase of banking and the financial markets, seeking to avoid a repeat of the financial meltdown that resulted in the nation’s deepest economic downturn since the Great Depression. Charles Kahn, a finance and economics professor who chairs the finance department, discusses the historic overhaul in an interview with News Bureau Business & Law Editor Jan Dennis.
What do you think of the sweeping new regulations for the nation’s financial system proposed by the Obama administration?
New legislation so far, on credit cards in particular, is pretty mild. The biggest changes are likely to be an outgrowth of the U.S. Treasury’s white paper on financial regulatory reform, issued a couple of weeks ago. It’s largely a statement of principles: Details are still to be filled in. But on the whole, the program makes a lot of sense. The main theme is the focus on systemic risk: the problems that arise when a crisis in one financial institution or market spills over into other parts of the economy. There’s a lot of concern with large, complex financial institutions, the ones often described as “too big to fail.” Now, there will be oversight over these institutions as a whole, beyond the current piecemeal regulatory oversight over their various components. There’s also attention paid to the markets and institutions that can transmit financial disruptions – money-market mutual funds, settlement systems, securitization procedures, and credit-rating agencies.
The president has blamed the financial crisis on outdated financial rules and “a culture of irresponsibility.” Do you agree?
To the first part: yes. But financial rules are always outdated. In a constantly changing environment the regulators need to be constantly catching up. To the second part: no. I understand that politically it is necessary to invoke moral failings as the cause of a financial crisis, but it doesn’t make a lot of sense: Does it mean that on the other hand we’re supposed to attribute financial development to a “culture of responsibility”?
Would the changes have prevented the current crisis and could they help ward off future financial meltdowns?
While the focus of the changes is good, my main concern is that since financial institutions are so innovative, it’s hard to believe that we’ll be able to foresee the transmission mechanism for the next shock. The last couple of financial crises have been transmitted by unexpected side effects in relatively new financial institutions. So I’d like to see more attention on repair rather than prediction. The new proposals do call for mechanisms for government takeover and unwinding of large complex financial institutions: the kind of procedures that the FDIC has carried out so successfully in the case of traditional banks. After all, to prevent financial meltdowns, the important thing is not to save the initial institution, but to keep to failure from having knock-on effects.
Wouldn’t that reward irresponsible behavior?
No. In fact, quite the opposite. Windfalls for management and owners of failing financial institutions are more likely to arise from the government’s need to make deals with them in the middle of a crisis, as we have seen. With wind-up procedures already in place, the power of failing institutions to make threats, by holding up the procedures, is greatly reduced.
Is there a danger of overregulation?
Back in November, I thought that was a big worry: that political leaders would feel it necessary to be seen doing something, whether that something made sense or not. Of course, there has been some political grandstanding. But the specific proposals that have come out so far have generally been sensible. If anything, the worry is that the rapid recovery of the financial institutions will mean that some of these sensible proposals won’t get implemented.
