If you’ve read me for more than two months, you probably know that I am an actuary, though not a practicing actuary at present. I grew up in the life insurance industry. It’s an unusual place for an investor to start, but there are some advantages:
There’s more, but my topic this evening is financial regulation generally. I’ve been thinking about it, and I have had a moderate shift in my views: I think it would be wise to reinstitute a modified version of Glass-Steagall, but modeled after the way that insurance regulation is done today. For solvency regulation, insurers are much better regulated than banks. The banking industry should imitate the insurance industry in a number of ways.
Here’s the main idea: Allow financial holding companies to own all manner of financial subsidiaries, but disallow:
This would bar complex ownership charts. There would be a big box at the top, with lines to little boxes below, but only one level of depth, and no lines between subsidiaries.
The view of the government toward financial holding companies should be this: we don’t care if you fail. We do care if your subsidiaries fail, so if the solvency of any of them is getting marginal, dividends to the holding company will be cut off.
Now, I would prefer the rest of the financial industry mimic the insurance industry, in that State regulation is better than Federal regulation. If you want to end too big to fail, split up banks into state subsidiaries. Each state regulator would separately determine solvency issues, and would limit dividends back to the holding company.
Remember, we don’t care if holding companies go broke. If a holding company goes broke, and all of the subsidiaries are solvent, the subsidiaries will easily be sold to other holding companies. The creditors of the bankrupt financial holding company will divide the spoils after a year or so. Cost to the taxpayers: zero.
And maybe, mimic the guarantee funds of the insurance industry, and let the financial subsidiaries self-fund the losses of their fallen competitors. Cost to the taxpayers: zero.
Under this sort of arrangement, you can have “financial supermarkets,” but they would be very different, because the solvency of each part would be separately regulated. You don’t want macro-regulators, they are far easier to fool; specialization in financial regulation is a plus; don’t give any credit to those who use a diversification argument. We are focusing on risks, not risk. Failure does not happen from risk in abstract, but from particular risks that were underrated.
Finally you need risk managers inside all regulated financial institutions that are either FSAs [Fellows in the Society of Actuaries] or CFAs [Chartered Financial Analysts]. I am both, though my FSA status is inactive, because I don’t pay the dues. Why is this valuable?
You need organizations with ethics codes to teach and monitor the behavior of those within. There are failures amid FSAs and CFAs, but society and legal punishment tends to decrease the occurrence.
If we did this, financial companies would be much more stable, and we would reduce the need for the FDIC. There would be personal ethics standards among risk managers inside financial companies, and less reason for regulators to compromise from political pressure.
This is my modified version of Glass-Steagall, which gives financial industries most of what they want, but offers solvency protections far beyond what we have today. Is this a good compromise, or what?