Roubini's Solution: Tougher Regulation of Bank Trading Practices

Roubini Warns of ‘Significant Amount of Froth’ in Markets:

He — along with other economists — has cautioned recently that the Federal Reserve must raise interest rates aggressively to avoid creating another asset-price bubble as happened earlier this decade in housing. “Monetary policy has to be more proactive to prevent asset price bubbles from occurring,” he said.

However, “it is not time to hike [rates] right now,” given the weakness in the U.S. economy, he said, so “you need another tool to prevent an asset bubble — regulation.”

“Either we [increase regulation] or we’re going to create another problem,” he said. “I’m somehow optimistic that a lot of that stuff is going to be passed by Congress — there’s a recognition that if we don’t, we’re going to create the seeds of the next crisis.”

What Roubini and others are acknowledging is that the Fed is providing easy money to the banks so that they’ll start lending again. For the most part that has not happened. Instead of money going into loans and corporate America, the money has gone into the markets - primarily the stock market but also commodities as well. The Fed can’t stop the easy money or it jeopardizes the economic recovery, but at the same time they’ve got a very real problem on their hands, namely “how do we prevent more and bigger asset bubbles?” Which, after all, is what got us into this mess in the first place.

Roubini’s solution is more and greater regulation on the trading done by banks and others. As long as betting on oil or the S&P 500 is more attractive to banks, versus making a loan to a corporation to grow their business and hire workers, the banks will make bigger and bigger bets. And since the OTC derivatives market is still going full-steam without any meaningful regulation from Congress, that is the method of choice for the banks.

Roubini has advocated that all derivatives must be traded on an exchange (which also means cleared through an exchange). This would do many things:

1. It would require margin be put up, based on the risk of the bet, and not based on some other factor.
2. That cash would be posted with the exchange and therefore prevent the massive - nearly infinite - leverage that’s available in the OTC markets.
3. It would prevent another market meltdown because everybody is making good on their bets every day, so nobody’s bets are going to come back to haunt them (think AIG).

You can listen to Roubini talking in this interview with the BBC.

Comments

[john s. gordon:]

increased regulation on trading & derivatives is long overdue/
> jack

Oct 20 08:41 AM

[Ferdinand E...:]

I don't know who Roubini is and don't want to know. When it comes to putting the US economy in order, I think that Ben and Larry can do the job.

Oct 20 08:50 AM

[Andrew Butter:]

Exactly right.

The biggest bubble now is long term Treasuries, a bubble in oil is brewing, which would be ironic, US taxpayers stake banks to speculate in oil, oil prices go up, they pay more for gas,

Interest rates need to be raised now, the effect on the economy was zero because banks didn't lend, so bad idea, drop it.

Oct 20 08:56 AM

[chap08:]

This is one of the times when Roubini talks perfect sense. Unfortunately, the amount he can offer in campaign contributions (bribes) isn't as big as the banks.

Oct 20 09:11 AM

[Bill S. Friend:]

The bailout to the biggest corporations in the country gave them much needed cash to pursue their insider information. Its too bad they cant short themselves (and each other) into insolvency again. What a wonderful financial model The United States of America sports. This debacle is resulting in the largest transfer of wealth to the richest individuals on earth, in history. They must just giggle with the thought of it.

Oct 20 09:20 AM