MONEY and BANKING LOW GRAPHICS

 


REGULATE OR NOT?

 

 


 
To regulate or not to regulate? That is the question. Or is it?
 

 

 

 Student 1

During election time, government officials are always talking about how they are going to help the economic growth of the society. They claim that they will decrease taxes, lower interest rates and make things more affordable by putting more money into the hands of the consumers, or the American public. But, at what price should we allow the government to regulate economic activity in society? Is regulation beneficial or detrimental to the well being of our economic markets? Throughout history, economic markets that are allowed to operate freely from government controls will eventually balance out and lead the economy in the right direction. Case in point, during the term of Alexander Hamilton, the government fixed the gold and silver ratio and we ended up with a defacto sliver standard. People were able to take advantage of an arbitrage (riskless economic profit) opportunity with countries in Europe and the US. Americans would sell gold in Europe to get more silver for it and then come back to America and sell the silver to obtain even more gold. If the government hadn’t fixed the ratio, the ratio would have been able to freely fluctuate and fix the arbitrage situation by evening out the ratios. Although regulation sometimes hinders the economic market in the United States, we can’t fully break free from partial government control. The Fed, which is the central banking authority in the US is partially independent and partially run by the government. If it became fully independent, it would be chaos because no one in the Fed would have any one answer to. It would cause a specific moral hazard problem called the principal-agent problem. The managers (agents) don’t have the same incentives as the owners (principals) and will engage in risky behavior that is unsuitable from the owner’s point of view. Being controlled and regulated about what sort of investments and activities that the Fed and federal chartered, as well as state chartered banks can engage in is necessary to keep the economy stable. THE FED ALSO INSTITUTED FEDERAL DEPOSIT INSURANCE WHICH SECURES A DEPOSIT UP TO A CERTAIN AMOUNT AGAINST BANK FAILURES. THOUGH GOVERNMENT REGULATION IS SOMETIMES HINDERING TO THE ECONOMY, IT ALSO HELPS TO MAKE PEOPLE MORE SECURE IN THEIR FINANCIAL DEPOSITS AND INVESTMENTS. The regulation issue is not a clear-cut yes or no answer. There are many arguments for and against regulation, but no one argument reigns supreme. Although some regulation is necessary to protect people’s money deposits, the economy should be allowed to fluctuate freely, to adjust itself when things go wrong. To regulate or not to regulate, that will forever remain the question.

 

 Student 2

I believe that “To regulate or not to regulate” really is the questions that governments have to ask themselves. This has become apparent and obvious during the past decade in the late 1990’s with all the financial crisis arising through out the world. For instance Mexico in ’94, Russia in ’95, S.E Asia and Asia proper in 1997, and most recently last year in both Argentina and Brazil.

One main cause for the tighter regulations has been the continual problem of asymmetrical information or the lack of proper data to make sound and accurate decisions by individuals or firms. Consumers are forever under the prey of moral hazards, which for example could be the improper or risky-ness of fund usage without the fund suppliers’ consent. The above would cause or lead to further economic problems later. For instance during the 1990’s with the liberalization of the financial sector of many Asian nations, Thailand, South Korea, Malaysia, their banks began to lend out tremendous amounts of money for real estate development or other ventures. Without proper expertise and lack of sufficient data about their borrowers’ pasts, many loans turned out badly. Many banks or financial companies suffered great losses as a result. THIS INCREASED THE UNCERTAINTY IN THE FINANCIAL MARKETS, WHICH LED TO SUBSTANTIAL DECLINES IN THEIR SECURITIES MARKETS.(1) With asymmetrical information, and the blurred line between a financially sound bank and a debt-reddened one, consumers assumed the worst and started a mass withdrawal. A bank run ensued. Many banks folded and the governments started to have to bail out them out, and with governments lacking enough funds, devaluations might have been considered by them. This added to currency speculations by financial moguls, eventually led to the ruins of many economies.

It is therefore necessary for governments to provide the legislation and facilities for proper financial regulations. IN JUNE 1988, THE BASEL ACCORD TO STANDARDIZE BANK CAPITAL REQUIREMENTS INTERNATIONALLY WAS INITIATED WITH THE INCREASED GLOBAL INTEGRATION. IT WAS FURTHER UPDATED IN 1999 TO INCLUDE A MINIMUM CAPITAL REQUIREMENT AND MORE RISK CATEGORIES TO ASSISTS THE CLIENTS IN DECISION MAKING.(2)

For instance, banks should be required by law to disclose their activities. Bank balance sheets checked regularly and prevented from undertaking risky ventures in real estate or junk bonds. A minimum reserve requirement or ration must set up to ensure consumer protection and pacify their fears of banking systems. Setting up a version of the U.S Federal Deposit Insurance Corporation would go a long way in maintaining stability.

Some would argue against regulations, as many believe it hinders competition. By setting up a fail-safe clause or bail-out plans, some banks might be tempted to take risks greater than needed. Since they know, the government will help them out. Regulations would also lead to inefficiency and complacency. Banks’ would lack the desire for growth or profit making if their activities will be continuously be checked on. This would also limit the choices of financial institutions for consumers, having to give their business to certain few certified institutions. This also brings about the question of who regulates them. The government or a independent body, who would have final say in decisions. If it was the government, they might also be prone to moral hazards for their political survival. If it is a independent one, will the government still bear responsibility to the voters, even though they have no control over the matter. INTERNATIONAL REGULATION PRACTICES AMONG NATIONS VARY AMONG NATIONS, MAKING IT IMPOSSIBLE TO HAVE A STANDARD SYSTEM. ALSO WHO KEEPS TRACK OF INTERNATIONAL SUBSIDIARIES, AGENTS AND FIRMS WITHIN THE OTHER NATIONS? THE HOST NATIONS OR THE HOME NATIONS WILL BEAR THE RESPONSIBILITY. IN THE END, A BALANCE BETWEEN BOTH WOULD PROBABLY BE THE MOST IDEAL SITUATION. ALLOWING THE KEY IMPORTANT POINTS OF REGULATION AND DEREGULATION TO ENSURE AN EFFECTIVE AND STABLE SYSTEM.(3)

References: (1)Mishkin, The economics of Money, Banking and Financial Markets (World Student Series:2002), 207 (2)Mishkin,285 (3)Mishkin,291

 

 

 Student 3

The question of how much to regulate depends on which sector in the economy the government wants to benefit. A deregulate financial system would help small investors and thus promote entrepreneurship and redistribution of resources. More specifically, this can be applied to Schumpeter’s idea of redistribution of resources to new and better entrepreneurs. Nevertheless, US main industries are highly consolidated. A regulated Banking industry helps big industries because almost every kind of investment instrument is directed to consolidated industries.

MISHKIN PROPOSES A VERY REASONABLE ARGUMENT IN FAVOR OF BANKING AND INDUSTRY CONSOLIDATION. He claims that deregulation, would reduce profits in the financial system 1. This would lead Banks to engage in riskier investments, thus increasing adverse selection and moral hazard problems. THIS ARGUMENT IS REASONABLE BECAUSE IN THE 80S WE SAW THAT THE HIGHER THE INVESTMENT RISK, THE GREATER ADVERSE SELECTION AND MORAL HAZARD PROBLEMS ARE. HOWEVER, THIS THEORY ALSO GOES AGAINST INNOVATION AND REDISTRIBUTION OF CREDIT.

A more heterodox point of view would support the idea of redistribution of credit to smaller investors. A LESS CONCENTRATED BANKING SYSTEM WOULD PROVIDE MORE INVESTMENT INSTRUMENTS FOR NEW ENTREPRENEURS. It is true that deregulation would lead to asymmetric information problems. However, it can also increase productivity because of better access to credit, which leads to more investment and more innovative ideas. It is hard to implement credit redistribution in the US because of many political ideologies and the power that consolidated corporations have over financial institutions.

A truthful deregulation of the US financial system is not possible because this country fears the idea of redistribution and the inflationary consequences of such actions. It is hard to promote total deregulation when powerful holding groups’ interests may be hindered. ALTHOUGH DEREGULATION MAY HELP SMALL INVESTORS, CORPORATIONS’ PROFITS SEEM TO BE MORE IMPORTANT THAN ENTREPRENEURIAL INNOVATION.

1. FREDERIC MISHKIN, CHAPTER 11, PG 288

 

 

 Student 4

In the financial markets, government regulation is absolutely necessary. THE GOVERNMENT REGULATES THE FINANCIAL MARKETS FOR THREE REASONS: TO INCREASE THE INFORMATION AVAILABLE TO INVESTORS, TO ENSURE THE SOUNDNESS OF THE FINANCIAL SYSTEM, AND TO IMPROVE CONTROL OF MONETARY POLICY. Asymmetric information results in two things: 1. Adverse selection, which occurs before investment and refers to bad credit risks seeking loans. 2. Moral Hazard, which occurs after financial decisions and refers to acts in which the borrower partakes in that may seem immoral to the lender. Government regulation helps to reduce adverse selection and moral hazard. ASYMMETRIC INFORMATION CAN LEAD TO WIDESPREAD COLLAPSE OF FINANCIAL INTERMEDIARIES, REFERRED TO AS FINANCIAL PANIC. TO PROTECT THE PUBLIC FROM FINANCIAL PANIC THE GOVERNMENT IMPLEMENTED 6 REGULATIONS: RESTRICTIONS ON ENTRY, DISCLOSURE, RESTRICTIONS ON ASSETS AND ACTIVITIES, DEPOSIT INSURANCE, LIMITS ON COMPETITION, RESTRICTIONS ON INTEREST RATES. The lemon problem in the stock market is also reduced with regulation that provides investors with MORE information to help their decision. For example, if Irving the investor wants to buy a stock with a certain amount of money, the only stock that he will be offered is one that is valued less than he’s willing to pay. A stock worth more money won’t settle for his payment, but a bad stock, a lemon, worth less will make a profit from his money. Regulation will give Irving a fair chance to make an intelligent decision. The principal agent problem, which says that agents have less incentive to maximize profits than the stockholders, is also reduced with government regulation. The free rider problem, when someone who doesn’t pay for information gets it from someone who does, is inevitable with financial decisions, but regulation attempts to reduce the problem. Without regulation in financial markets, investors would have less opportunity to make efficient economic decisions.

 

 Student 5

Regulations can be extremely beneficial to society. They allow for fairness in rules in which everyone must accept. The extent of regulation, however, is a very controversial issue. ONE WAY IN WHICH I FEEL REGULATION CAN BE REDUCED WAS FOUND when reading Professor Kyn’s research paper. I agree with his proposal to reduce regulation on mutual funds. ALTHOUGH SOME REGULATION TO CONTROL UNETHICAL INVESTORS IS NECESSARY, less regulation allows for a much greater number of companies to participate in the market. This, in turn, creates more competition, and PRODUCES a greater efficiency BECAUSE the market is able to move closer to its equilibrium. “AMERICAN EXPERIENCE SHOWS THAT THE PROMOTION OF COMPETITION IS MUCH BETTER PROTECTION OF A SMALL INVESTOR THAN ANY ADMINISTRATIVE AND LEGAL REGULATION WHICH OFTEN INHIBITS RAPID DEVELOPMENT OF COMPETITION AND IN GENERAL REDUCES THE GENERAL EFFICIENCY OF THE INDUSTRY,” (Kyn, Development and Regulation of Investment Funds In USA). The maximum efficiency would be achieved by a combination of regulations, but also on other incentives to decrease supply and increase the demand of the stock market. Examples of this may be to issue a TEMPORARY HIGH CAPITAL GAIN tax, ISSUE LONG TERM BONDS, OR EVEN INCREASE THE AMOUNT OF FOREIGN CAPITAL. ONE WAY IN WHICH I FEEL REGULATION IS ESSENTIAL TAKES PLACE in the control over financial institutions. This control over them allows the public to be able to watch over something they have assets in. Without EFFICIENT regulation, financial institutions will act like a beaurracracy AND TRY TO maximize their power. THIS, in turn, may result in such things as high inflation rates and an increase in the money supply. Too much regulation, on the other hand, may let the decisions of the institutions reflect the interests of the public, and not necessarily what is most beneficial to the country as a whole. IN MY OPINION, IT SEEMS OBVIOUS that some form of regulation is necessary for most financial projects. HOWEVER, I FEEL if there is too much, a market will be PREVENTED FROM ACHIEVING ITS MAXIMUM EFFICIENCY.

 

 Student 6

To regulate or not to regulate? That is the question! My economic and history studies up to this point have lead me to believe that this clearly is the central question of economic thought. Karl Marx one of the most influential minds ever in both economic and social thought, spurred the Cold War of the US vs. Russia, Reagan vs. Gorbachev, and more elementary capitalism vs. communism (socialism). The economic underpinnings of capitalism and communism can be seen purely as the question of regulation. This question is at the head of every economic decision made. The question of regulation some would say lies at the heart of the difference between Democrats and Republicans in America. It is then, no surprise that those economic thinkers who we think of as most profound/revolutionary are those thinkers who have made strides to deal w/ the question of regulation namely: Adam Smith, Karl Marx, and more recently John Nash. There can be no doubt that the question of whether or not to regulate is one of, if not the central question in economics. What is difficult is to make the decision of regulation or not; a review of some past examples will hope to show that the less regulation the better. These examples will include the evolution of the banking structure and the impact of less regulation and a look at the former Soviet Union and its attempts to regulate. (Note: this first paragraph represents an answer to one way in which the question can be interpreted. The addition of “Or is it?” at the end of the question makes it seems as though it is asking: “is regulation the central question of economics?” To this question I have answered “yes”. The next section will answer the second important aspect of the question: “to regulate or not to regulate”. In this question I answered briefly because I knew I had an interesting article from The Wall Street Journal I wanted to use as evidence to support my general claims.) This question comes to an interesting conclusion that seems paradoxical; free market economies operate better (non-regulated) while institutions within those markets may need regulation to keep them in “check” and running efficiently. Examples of this would be banks and financial investment institutions. After an analysis of this question an interesting conclusion will arise. That being that regulations may in fact allow banks and other financial institutions to run more freely. Specific examples will be discussed in detail. The United States has enjoyed great success operating under a free market economy. It has been a model-student in Adam Smith’s school of invisible hand economics. It’s laissez-faire economic style has been a model many countries have attempted to replicate in an attempt to duplicated the United States success. Its success as a free market economy is highlighted by the failed attempts at communism and socialism exhibited in the former Soviet Union and China under Marx’s ideology. It is interesting to note that the regulated economies of the former Soviet Union may have in effect been efficient, it was only in comparison to the success of America that drove its people to despise the system of regulated economies. It thus does not come as a surprise, that Reagan effectively poured salt in the wounds of the former Soviet Union’s people, by dumping Levis blue jeans, Rock-N-Roll music, and all the other freedoms that came with America’s free market economy into red square. One thing is clear America does not like regulation whether it be in politics, government, financial institutions, or our private lives. This is most evident in looking at the movement of America exhibited in question 3. Is all this deregulation really a good thing? Up until a year ago I would have based my answer to this question solely on the comparison on capitalism vs. communism that I learned in EC391. Now, however, I am forced to take my new knowledge (stemming from EC341) and apply it to this question. The solution to these comparisons is a constant struggle between the enjoyment of consumption and the necessary evil: control. This struggle is best represented by Alan Greenspan in his comments on the abolition of the Glass-Steagall Act: “the savviest policy makers knew they were making a choice ‘between economic growth with associated potential instability, and a more civil…way of life with lower standard of living”. After praising the abolition of Glass-Steagall in question 3, I now must call into the question the results of this decision. This may have been the green light for, “lenders recklessly lowering loan standards in pursuit of lucrative public offerings; banks marketing bad loans to an unsuspecting public” (TWSJ). Glass-Steagall now seems as though it was a blessing in disguise. If it was still in practice there is no way that J.P. Morgan and Citigroup would have been in a position to lend money and underwrite securities for Enron and WorldCom, as they did in their attempt to create “diversified financial behemoths” (TWSJ). It seems the founders of the Glass-Steagall Act fears were right, they recognized “money is the route of all evil” and set out to keep it in ‘check’ in our free market (unregulated) economy. It seems even in a well functioning free market economy regulation is a necessary evil!

 

 Student 7

The real question is “how” to regulate, not “if”. As the Savings and Loans Scandal of the mid-‘80s shows, largely removing regulations on the banking industry, AS WAS DONE IN 1982, however politically popular in the short-term, is disastrous.

 Because the problems of asymmetric information are similar throughout the world, , regulation of banks abroad is often similar to that in the U.S. Some such regulation includes restrictions on competition, consumer protection, band supervision, disclosure requirements, government safety nets, and restrictions on bank asset holdings.

The government must be fair to U.S. financial institutions in order to allow for competition with foreign banks, etc. Yet it must also set regulations to deal with the problems of moral hazard and adverse selection. If, for instance, the government continues to ensure deposits and loans but eases regulations which had encouraged banks to take risk into account when issuing loans, banks will naturally (and without any danger to themselves) tend to issue highly risky loans which could potentially yield higher profit for the bank.

One strong case for an independent Federal Reserve argues that were the Reserve to be under the thumb of vote-hungry politicians, an inflationary bias would result. And although today the Federal Reserve may appear at first glance to be highly decentralized, in actuality, it functions as a single, unified central bank, which is largely immune to political pressures.

“How?” , then, dictates that oversight organisms such as the FDIC, Federal Reserve, and those created in the 1989 FIRREA legislation AND FDICIA OF 1991, continue to operate in order to balance the forces (i.e. political, personal, profit-maximization, etc.) which lead to moral hazard ASYMMETRIC INFORMATION and adverse selection.

Such legislation also helped rid the use of the too-big-to fail policy and limited brokered deposits as well as requiring immediate corrective action to deal with distressed banks. Risk-based deposit insurance premiums were also part of the package. Yet the major victory here was reducing banks’ incentive to write high-risk loans, thus reducing taxpayer risk.

Another important point to make is that the fact that banking crisis across the globe share striking and universal similarities indicates that similar forces (i.e. asymmetric information, adverse selection, and moral hazard) are continuously problematic. Thus, it should be a universally held belief that the question is never “if” banks and financial institutions should be regulated, but, instead, “How”.

 

 Student 8

There is no correct answer to the questions. Since most of the systems of the developed countries have regulated banking systems, it seems that different kinds of financial institutions need organizations that can control them. Securities (AND EXCHANGE) commission watches financial markets, without it financial frauds would happen even more often. Most of societies need some control over them, some centralized power that can oversee their activities. Federal Reserve Bank is considered one of the of the most important organizations if the world. The best thing about Fed Reserve Bank that it regulates banking system of the country without being really noticed. It was a fear of Fed not to be too centralized so they won't harm private sectors. And the best thing about it that even though it's centralized system that regulates everything it doesn't really make it worse for private banks. On the other hand, it does enormous job by setting interest rates, giving deposits to banks, and oversees different operations of financial institutions. Without Fed it is obvious that many banks would go out of business, because of the loans that it gives to banks and required reserve regulations banks do not default very often, and, thus people do not loose their money. Even though it is still a question what is better to regulate or not, no system has proven to survive without being overseen. It is a good example from physics that any systems if left alone will eventually turn into chaos (thermodynamics idea TO BE MORE EXACT IT IS ONE OF THE FORMULATIONS OF THE SECOND LAW OF THE THERMODYNAMICS, WHICH STATES THAT ENTROPY (MEASURE OF CHAOS) INCREASES IF THE SYSTEM IS LEFT ALONE ). Whether or not the chaos of good for economy is still a question, but it doesn't seem to be very attractive for financial institutions. Also, no society has proven to live well in anarchy, without nobody to regulate and control activities.

 

 Student 9

To Regulate or not to Regulate When the government decided to regulate it is usually with good intentions. The government decided to regulate the banking industry, trying to help small people from being taken advantage of. An example is the Glass-Stegall Act, which separated commercial banks and securities divisions. This like many other regulations have either been repealed or amended. Natural market forces will either force regulations to repeal or be amended. Regulations act as restrictions and can hinder economic growth. Some bank regulations that ensure that the banks service only a certain aspect such as individuals or personal accounts can be helpful to those customers but it is harmful to the bank. Since the bank can only specialize, and it is prohibited to diversify due to deregulation, what would happen in an economic change? Even if it was a positive change it could still destroy the bank. An example Bank 1 is regulated and must only deal with individual accounts, and if interest rates drop down by a lot, people will with draw their money from savings accounts. The bank will have no funds and no other source of income. In my view markets should barely be regulated. Regulation reduces the amount of money that will go to the hands of the public. Large companies will always be able to get funds. But the regulation constrains small banks and institutions and therefore hurting the common people by either limiting or eliminating their options.

 

 

 

 

 

 

 

 

 

 

 

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