Stephen Foley: Panicky new rules that miss the point

US Outlook: Forcing derivatives trading on to exchanges will bring transparency and cut counter-party risk
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The Independent Online

Feeling better? Even from their counting houses, Wall Street bankers could hear the cheering crowds when headline writers declared "Obama goes to war on the banks".

But the bigger the headline, the further away the underlying policy pronouncement tends to be from the causes of the credit crisis and the systemic problems that need to be addressed. That is certainly the case with the two new rules cooked up by a panicked White House this week.

Wall Street has been promised the limits on the size of institutions' balance sheets will be set above current levels, so they clearly would have done nothing to prevent the 2008 conflagration. And the decision to ban financial firms from holding both a deposit-taking bank and running a hedge fund or proprietary trading desk also seems peripheral. Bear Stearns, AIG and Lehman Brothers had no commercial banking operations but managed to pull down the entire system very efficiently, thank you very much.

It is the scale of the interconnections between firms, rather than their size per se, which threatens the system. It is not what businesses banks own, but how their businesses behave, that is most pertinent.

Reforms already on the table tackle these crucial issues. A resolution authority, which ought to be pre-funded by the industry, will allow for an orderly wind down of complex firms. Forcing derivatives trading on to exchanges will bring transparency and cut counter-party risk. Regulators – and counterparties themselves – will set organic limits on size by upping capital requirements, demanding lower leverage and asking for extra collateral for trades. There is a reason this is the consensus. Reaching for eye-catching new initiatives involves reaching outside the consensus, a line that was crossed this week.