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Prosperity Unleashed: Smarter Financial Regulation the Heritage Foundation Prosperity Unleashed: Prosperity Smarter Financial Regulation Smarter The Heritage Foundation Prosperity Unleashed: Smarter Financial Regulation Edited by Norbert J. Michel, PhD Prosperity Unleashed: Smarter Financial Regulation Edited by Norbert J. Michel, PhD © 2017 by The Heritage Foundation 214 Massachusetts Avenue, NE Washington, DC 20002 (202) 546-4400 | heritage.org All rights reserved. Cover Photo © istockphoto.com Printed in the United States of America. CONTENTS v Contributors 1 Introduction PART I Banking Regulation Reforms 15 Chapter 1 • Deposit Insurance, Bank Resolution, and Market Discipline Mark A. Calabria, PhD 29 Chapter 2 • A Simple Proposal to Recapitalize the U.S. Banking System Kevin Dowd, PhD 37 Chapter 3 • A Better Path for Mortgage Regulation Diane Katz 49 Chapter 4 • Money and Banking Provisions in the 2016 Financial CHOICE Act: A Major Step Toward Financial Security Norbert J. Michel, PhD PART II Securities Regulation Reforms 61 Chapter 5 • Securities Disclosure Reform David R. Burton 83 Chapter 6 • The Case for Federal Pre-Emption of State Blue Sky Laws Rutheford B. Campbell Jr. 95 Chapter 7 • How to Reform Equity Market Structure: Eliminate “Reg NMS” and Build Venture Exchanges Daniel M. Gallagher 105 Chapter 8 • Reforming FINRA David R. Burton PART III Regulatory Agency Structure Reforms 129 Chapter 9 • Reforming the Financial Regulators Mark A. Calabria, PhD, Norbert J. Michel, PhD, and Hester Peirce 155 Chapter 10 • The World After Chevron Paul J. Larkin, Jr. 167 Chapter 11 • Transparency and Accountability at the SEC and at FINRA Thaya Brook Knight PART IV Government-Preference Reforms 179 Chapter 12 • The Massive Federal Credit Racket Diane Katz 201 Chapter 13 • Reforming Last-Resort Lending: The Flexible Open- Market Alternative George Selgin, PhD 213 Chapter 14 • Simple, Sensible Reforms for Housing Finance Arnold Kling, PhD 219 Chapter 15 • A Pathway to Shutting Down the Federal Housing Finance Enterprises John L. Ligon 235 Chapter 16 • Fixing the Regulatory Framework for Derivatives Norbert J. Michel, PhD PART V Protecting the Integrity of Finance 255 Chapter 17 • Designing an Efficient Securities-Fraud Deterrence Regime Amanda M. Rose 263 Chapter 18 • Financial Privacy in a Free Society David R. Burton and Norbert J. Michel, PhD 287 Chapter 19 • How Congress Should Protect Consumers’ Finances Alden F. Abbott and Todd J. Zywicki 295 Chapter 20 • Reducing Banks’ Incentives for Risk-Taking Via Extended Shareholder Liability Alexander Salter, PhD, Vipin Veetil, and Lawrence H. White, PhD PART VI Enabling Next Generation Finance 307 Chapter 21 • Improving Entrepreneurs’ Access to Capital: Vital for Economic Growth David R. Burton 335 Chapter 22 • Federalism and FinTech Brian Knight 349 Chapter 23 • A New Federal Charter for Financial Institutions Gerald P. Dwyer, PhD, and Norbert J. Michel, PhD CONTRIBUTORS Alden F. Abbott is Deputy Director of, and John, Barbara, and Victoria Rumpel Senior Legal Fellow in, the Edwin Meese III Center for Legal and Judicial Studies at The Heritage Foundation. David R. Burton is Senior Fellow in Economic Policy in the Thomas A. Roe Institute for Economic Policy Studies, of the Institute for Economic Freedom, at The Heritage Foundation. Mark A. Calabria, PhD, is Director of Financial Regulation studies at the Cato Institute. He was previously a member of the Senior Professional Staff of the U.S. Senate Committee on Banking, Housing, and Urban Affairs. Rutheford B. Campbell Jr., is Spears–Gilbert Professor at the University of Kentucky College of Law. Kevin Dowd, PhD, is Professor of Finance and Economics at Durham University in the United Kingdom. Gerald P. Dwyer, PhD, is Professor of Economics and BB&T Scholar at Clemson University, an Adjunct Professor at the University of Carlos III in Madrid, and a Research Associate at the Centre for Applied Macroeconomic Analysis at Australian National University. He was previously Director of the Center for Financial Innovation and Stability at the Federal Reserve Bank of Atlanta. Daniel M. Gallagher is president of Patomak Global Partners, a capital markets consulting firm based in Washington, D.C. He was an SEC Commissioner from 2011 to 2015, and prior to that was Deputy and Co- Acting Director of the SEC’s Division of Trading and Markets. Diane Katz is a Senior Research Fellow for Regulatory Policy in the Thomas A. Roe Institute for Economic Policy Studies, of the Institute for Economic Freedom, at The Heritage Foundation. Arnold Kling, PhD, is a Senior Affiliated Scholar and a member of the Financial Markets Working Group at the Mercatus Center at George Mason University, as well as an Adjunct Scholar at the Cato Institute. Brian Knight is a Senior Research Fellow with the Financial Markets Working Group at the Mercatus Center at George Mason University. Thaya Brook Knight is Associate Director of Financial Regulation Studies at the Cato Institute. Paul J. Larkin, Jr., is Senior Legal Research Fellow in the Edwin Meese III Center for Legal and Judicial Studies at The Heritage Foundation. John L. Ligon is Senior Policy Analyst in, and Research Manager of, the Center for Data Analysis, of the Institute for Economic Freedom, at The Heritage Foundation. Norbert J. Michel, PhD, is a Research Fellow in Financial Regulation in the Thomas A. Roe Institute for Economic Policy Studies, of the Institute for Economic Freedom, at The Heritage Foundation. The Heritage Foundation | heritage.org v Hester Peirce is a Senior Research Fellow in, and Director of, the Financial Markets Working Group at the Mercatus Center at George Mason University. Amanda M. Rose is Professor of Law at Vanderbilt University Law School. Alexander Salter, PhD, is Assistant Professor of Economics at Rawls College of Business, and Comparative Economics Research Fellow at the Free Market Institute, both at Texas Tech University. George Selgin, PhD, is a Senior Fellow in, and Director of, the Center for Monetary and Financial Alternatives at the Cato Institute, and Professor Emeritus of Economics at the University of Georgia. Vipin Veetil is an alumnus of the Mercatus Center PhD Fellowship and Dissertation Fellowship Programs. Lawrence H. White, PhD, is Professor of Economics at George Mason University, and a member of the Financial Markets Working Group at the Mercatus Center at George Mason University. Todd J. Zywicki is George Mason University Foundation Professor of Law, and Executive Director of the Law & Economics Center at George Mason University. vi Prosperity Unleashed: Smarter Financial Regulation INTRODUCTION rosperity Unleashed: Smarter Financial Regulation provides solutions to the core regulatory problems P that have existed in U.S. financial markets for decades. Policymakers can implement these solutions to make U.S. financial markets more dynamic, resilient, equitable, and accountable than ever before. Poli- cymakers should implement these solutions because a well-functioning financial sector results in a society with more goods and services, more employment opportunities, and higher incomes. A smoothly running financial system makes it easier and less costly to raise the capital necessary for launching or operating a business, to borrow money for buying or building a home, and to invest in ideas that improve productivity and increase wealth. Financial enterprises are the arteries regulations steadily increased after 1999, long through which money from one sector of the before Dodd–Frank was even contemplated. economy flows into others, creating jobs and Financial firms—not just banks—have long wealth in the process. Just as with nonfinancial dealt with capital rules, liquidity rules, disclo- businesses, excessive government regulation sure rules, leverage rules, special exemptions disrupts that smooth functioning, preventing for rules, and the constant threat that regula- financial firms from serving the needs of their tors would make up new rules or enforce old customers and society. Despite these disrup- rules differently. There is no doubt that, for tions, policymakers have long treated finan- decades, the U.S. regulatory framework has cial companies differently than nonfinancial increasingly made it more difficult to create businesses. In particular, government policies and maintain jobs and businesses that benefit have—for decades—empowered regulators to Americans. One of the main reasons the regu- manage private risks and mitigate private loss- latory regime has been counterproductive for es in an effort to prevent financial-sector tur- so long is because it seeks to micromanage moil from spreading to the rest of the economy. people’s financial risk, a process that substi- This approach, rarely contemplated in nonfi- tutes regulators’ judgments for those of pri- nancial industries, has demonstrably failed. vate investors. This approach provides a false The 2008 financial crisis is an obvious ex- sense of security because the government ample of a poorly functioning financial sector. confers an aura of safety on all firms that play Financial firms funded too much unsustain- by the rules, and it is bound to fail for at least able activity largely because of the rules and three reasons: (1) people take on more risk regulations they faced, including the wide- than they would in the absence of such rules; spread expectation that the federal govern- (2) people have lower incentives to monitor fi- ment would provide assistance to mitigate nancial risks than they would otherwise; and losses. Yet, the dominant narrative that sup- (3) compared to other actors in the market, ported passage of Dodd–Frank in 2010 was regulators do not have superior knowledge of that deregulation in financial markets, begin- future risks. ning in the 1990s, caused the crash. Ostensi- In addition to these shortcomings, the U.S. bly, the unbridled pursuit of profits by “Wall regulatory framework, for at least a century, Street” drove the global financial system to has repeatedly protected incumbent firms the brink of collapse. But this story is wrong. from new competition—the very market forc- There was no substantial reduction in the es that drive innovation, lower prices, and scale or scope of financial regulations in the prevent excessive risk-taking.
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