How Would You Simplify the Financial-Reform Bill? A Freakonomics Quorum

Last month, roughly two years into a global financial maelstrom, the U.S. Congress passed a financial-reform bill. It was more than 2,300 pages long, addressing everything from derivatives to consumer financial products to oversized banks. We asked a few clever people a simple question:

If you were writing the financial-reform bill and, instead of more than 2,300 pages, were limited to five specific reforms, what would they be?

Here are their answers.

Barry Ritholtz is the CEO and Director of Equity Research at Fusion IQ; he also writes the finance blog The Big Picture and is the author of Bailout Nation.

“Three decades of “Radical Deregulation” freed banks to engage in all manner of reckless behavior. Leaving the status quo in place guarantees? another crisis in the future. Historical patterns suggest the next calamity will dwarf the collapse of 2007-09″

The lessons of this crisis are manifestly obvious: Three decades of “Radical Deregulation” freed banks to engage in all manner of reckless behavior. Leaving the status quo in place guarantees?another crisis in the future. Historical patterns suggest the next calamity will dwarf the collapse of 2007-09.

How to fix it? Here are the first 5 ideas out of a longer list in Bailout Nation that not only would have prevented this past crisis, but would also prevent the next one:

  1. Derivatives: The Commodity Futures Modernization Act of 2000 (CFMA) exempted derivatives such as Credit Default Swaps (CDSs) and Collateralized Debt Obligations (CDOs) from all regulatory oversight. There were no reserve requirements, capital minimums, exchange listings, transparent open interest reporting, or counter-party disclosures. The easiest thing to do would be to repeal the CFMA. Derivatives should be regulated like any other financial products: they should be traded like stocks, bonds, option, and futures – on exchanges, with capital requirements, and full disclosure of counter-parties, with full open interest reported.
  2. Ratings Agencies: The Nationally Recognized Statistical Rating Organizations (“NRSRO”s) – Moody’s, S&P, and Fitch – slapped their highest triple-A ratings on paper that was actually junk. They did so because investment banks paid them to. This payola was a fatal abuse of their unique regulatory role. The conflict-ridden business models of the ratings oligopoly needs to be repaired. Eliminate the “underwriter pays” structure. Open up ratings to true competition – including open source. Randomly assign ratings agencies so “Rate Shopping” is eliminated.
  3. Leverage: Prior to 2004, Wall Street firms were limited to 12-to-1 leverage by the 1975 net capitalization rule. In 2004, the five largest banks received a waiver, allowing their leverage to go up to 25, 30, even 40, to 1. Congress should overturn the SEC exemption and legislate that investment banks conform to the pre-collapse leverage of “merely” 12 to 1.? And the SEC should lose its discretion over this issue.
  4. Restore Glass Steagall: The repeal of Glass Steagall wasn’t the cause of the collapse, but it contributed to the severity of the crisis. The FDIC-insured depository banks should be separated from the risk-embracing investment houses. Prior to the repeal of Glass Steagall in 1998, the market had regular crashes that did not spill over into the real economy:? 1966, 1970, 1974, and most telling of all, 1987.? Wall Street’s occasional bouts of madness did not freeze credit for the real economy. It’s time to return to a banking system divided into two halves: speculative investing and underwriting, and commercial taxpayer-backed depository banks.
  5. Too Big To Fail: As Nixon Treasury Secretary George Shultz famously quipped, “If they are too big to fail, make them smaller.” The bailouts have reduced competition and concentrated economic power in a few firms. More than 65% of the depository assets are now held by a handful of huge banks – and they are still less than stable. Seven thousand small and regional banks hold the remaining 35%. Bring back competition to the banking sector. Limit the size of the behemoths to no more than 5% of the total US deposits. If we have to break up the biggest banks – JPM, Citi, Bank of America – so be it.

Justin Wolfers is a Professor of Business and Public Policy at the University of Pennsylvania and a regular contributor to this blog.

“If it walks like a bank and quacks like a bank, it’s a bank. Bring all banks out of the shadows and into the glare of the regulatory sunlight.”

Financial Reform You Can Fit on the Back of a Napkin:

  1. If it walks like a bank and quacks like a bank, it’s a bank. Bring all banks out of the shadows and into the glare of the regulatory sunlight.
  2. Too often financial information is written with two pens. The small font sizes provide enough cover for a lawyer to sign off, but in larger type, they tell a story that is misleading enough to encourage a steady stream of suckers. That doesn’t seem fair. Here’s a different approach. If your firm’s marketing materials lead a random sample of 100 Americans to believe that the mortgage, or credit card, or other financial product is less onerous or risky than it actually is, then your marketing materials are misleading, and your firm is liable for damages.
  3. An old idea: a Tobin Tax-a small fee attached to every financial transaction. It won’t stop me from saving in my 401(k), but hopefully it would discourage high-frequency traders from wasting their lives hoovering up those nickels that occasionally (and fleetingly) appear on the floor of the exchanges. There’s not a single factory that was built, or a school financed, as a result of their efforts. Indeed, if they weren’t picking up those nickels, those nickels might even remain in our retirement accounts. More generally, let’s encourage the productive side of finance-the part that turns your savings into a firm’s new investment-but discourage financial parasites.
  4. Allow short sellers. When the regulators struggle to find financial misdeeds, let’s enlist the private sector for help. One approach would be bounties for uncovering financial malfeasance. A cheaper approach is to allow-indeed, encourage-short sellers. The private sector can find out who the charlatans are, bet against them, and then reveal this information to the market.
  5. Notice that these are all broad legal principles, not bright line rules? The problem with bright-line legal rules is that clever lawyers figure out clever loopholes. But the problem with broad legal principles instead is that regulators are too easily “captured,” befriending those they are meant to oversee. I’m suggesting broad legal principles, but with a twist. I would raise the pay of financial regulators by half, but in return let’s shut down the pathway from regulator to regulated: once you’ve worked at overseeing an industry, you can’t work in the industry for at least five years.

Nassim Nicholas Taleb is the author of The Black Swan. He is at work on a paper called “Why Did the Crisis of 2008 Happen?

“The captain goes down with the ship…”

Time to realize that capitalism is not about free options. The captain goes down with the ship — all captains and all ships — making everyone involved in risk-bearing accountable, no exception, none. Morally, legally, whatever can be done. That includes the Nobel (Bank of Sweden), the academic establishment, the rating agencies, forecasters, bank managers, etc.

Raghuram Rajan is a Professor of Finance at the University of Chicago and the former Chief Economist at the IMF. He is the author of Fault Lines: How Hidden Fractures Still Threaten the World Economy.

“Reduce the possibility that any financial institution will be too systemic to fail, and ensure that there are substantial classes of securities issued by each of these entities that will lose everything if the entity has to be bailed out…”

  1. Get the government and its agencies out of the business of supporting housing through tax and lending subsidies. While a cold-turkey strategy will probably be destabilizing, a steady and well-defined path of disengagement can be spelled out (e.g., steadily reduce the mortgage-interest tax deduction over a number of years). Breaking up Fannie and Freddie, privatizing the parts, and sending clear signals that their debt will not be guaranteed by the government (see below) have to be part of the solution.
  2. Reduce the possibility that any financial institution will be too systemic to fail, and ensure that there are substantial classes of securities issued by each of these entities that will lose everything if the entity has to be bailed out (these securities are more popularly known as contingent capital). In other words, let investors know they will feel the pain, and thereby give them the incentive to put more constraints on bank risk-taking. I would explore the possibility of reducing the extent to which deposits are insured as banks exceed a threshold size.
  3. If bank boards will not do it on their own, regulators should press bankers to have more long-term skin in the game (that is, money they will lose if the strategy does not pan out over the long run), and let them have more to lose if their bank is ever bailed out.
  4. Reduce the number of regulators (to fewer than the current bill suggests), let the surviving ones meet regularly in a systemic risk council (which would also have regulatory powers over systemically important financial firms), and ensure that a new Office of Financial Analysis collects timely data on systemic risks and exposures, analyzes it for the benefit of the regulators, but also puts out much of the data and analysis in the public domain so that financial markets can monitor risks directly and keep a check on regulators (I am not going much beyond the bill on this one).
  5. Get the Fed to focus on financial stability as an important element of monetary policy. The focus on employment and inflation, largely to the exclusion of financial stability (except in a panic), has been an important weakness in its policies.


Any single suggestion here would be markedly better, in and of itself, than what we wound up getting.


One thing that I'd like to see happen would be to have more types of transactions declared, by law, unenforceable.

For example:
Say I'm a bank, and I think that it would be good to write a loan to you of 100% of the cost of a house. Now say that only 80% of that is "enforceable" in bankruptcy, usable for foreclosures, etc., and that any loan that's written for more than the 80% is, in its entirety, unenforceable (though the bank can report the default to credit bureaus).

Suddenly, a few things happen:
1) Loans get automatically split into the part up to 80% and any part above 80%.
2) Banks only give loans above the 80% to people they are *really* sure can pay them back. Those loans don't disappear; they're just much harder to get (remember that it still goes on your credit record).
3) If people fall on economic hardship, they can make that top part of the loan go *poof!*, thus reducing their payments.
4) Housing prices don't go up so fast, because the loans are harder to get.
5) And, most importantly, not *one* regulator gets added. The banks have to self-regulate -- or they end up with a bunch of really lousy, unenforceable loans. Now, the regulators still have to make sure the banks have proper capital available, but some of the most risky loans don't get written.

I'd do the same for any loan written without solid proof of income/ability to pay: you write the loan, you take the chance. If you don't make sure someone can pay, then, if it goes south, you lose. MAJOR incentive for banks to get it right, even without more regulations.

And, lastly, require financial institutions to insert a clause in their employment contracts that states that, in the event of a government bailout/rescue, all provisions of that contract are null and void. Sure, you may be able to assume that the government may be forced to bail you out, but you can't also assume that you still get your bonuses/salary/etc. It's one, OR the other -- not both.

Wherever possible, I prefer injecting unenforceability over enacting new regulations. It keeps our oversight requirements to a minimum, and still provides security against some of the more egregious risk-taking.



Fix incentives - don't let anyone to pay out short-term incentives on long-term risks. Majority of bad decisions I've seen were driven by "lets make a profit today and get those nice bonuses, and lets hope we retire by the time the risk materializes'...


You don't need a "Top Five." You just need one. It is directed at all company executives.

"If your company acts, as a matter of policy or general understanding, in any way that can rightfully be considered unfair, unjust, unethical, misleading, improper, illegal, less than in good faith, or immoral, and it results in damages to customers/partners/etc. who acted in good faith, AND your company cannot fully cover the damages, then you, as CEO or other executive officer, are PERSONALLY responsible. You cannot hide behind a corporation. Your personal assets, including your home, savings, pensions, and any other assets of value, here or abroad, are subject to seizure and forfeiture. Further, you are subject to imprisonment, including the death penalty."

Forget thousands of pages. Make the players have their own skin in the game (not just the corporation's), and the game will change instantly. It will still be fierce competition, but no one is going to play the loopholes when they cannot only make their company go bankrupt, but can lose everything themselves, including their lives.

Draconian? YES.

Needed? YES.

Otherwise, you can be sure they will do it again, eventually.


Eric M. Jones

Justin Wolfers for president.

Yes, you have to gulp at the 2300 pages. I just can't imagine anything comprehensible in that length.

Since the US Tax Code is from 2,400 to 1,000,000 pages depending on who you ask, I suspect that the Financial Reform Bill is similarly disposed to expand and contract like a giant accordian...depending on who you ask.

The system is broken. Gold coins, dried beans and canned goods...that's my advice. For those filthy-rich people who think they got away with it......?

Change in washington is what's left for the taxpayers. Loose change.

The health bill is at 2400 pages, and let me guess what these 4000 pages have in common, written mostly by lobbyists.

And that's another reason people are unhappy with Obama.


First of all this is a well-written article. I couldn't agree more with the first 5, the snippet about using short-sellers as market regulators on this front has always appealed to me, and I like the idea of "skin in the game from the third section.

The only change I would say is that the "skin in the game" should not necessarily only be applied to bank regulators, but some individual responsibility should be placed on homeowners or potential homeowners. To live in a house without a down-payment or proof over the ability to pay (income) is absurd; with no "skin in the game" it is too easy to walk away as the costs increase and as a dream house becomes an investment burden.

Furthermore, this "skin in the game" applies as these securities are bundled and passed on. How should financial reform go about fixing the problem where "those securities are no longer in our hands?" It's no wonder Freddie and Fannie were doomed as they were passed troubled assets labeled good investments... but whose fault was it? The mortgage companies selling bad loans, or the insurance companies buying them? Are we in a buyer beware world or do we call for more transparency in the books??


Oscar McLean

Well have read about what has happen in the financial market before and after the meltdown I feel that Barry Ritholtz has what it takes to get the reform done right. Barry Ritholtz reform the financial market asap. Put that transaction fee in there as well.


"Get the government and its agencies out of the business of supporting housing through tax and lending subsidies. While a cold-turkey strategy will probably be destabilizing, a steady and well-defined path of disengagement can be spelled out (e.g., steadily reduce the mortgage-interest tax deduction over a number of years). Breaking up Fannie and Freddie, privatizing the parts, and sending clear signals that their debt will not be guaranteed by the government (see below) have to be part of the solution."

Best idea of the lot

Howard Brazee

I'm a big believer that delayed stock options should be how CEOs make most of their money. By "delayed", I mean by a decade. Get our corporations working for the long term. Don't let the CEO get wealthy by passing problems to the next guy.


It would be a very long comment going into all the proposals, although I pretty much agree with Mr. Ritholtz
and Mr.Wolfers. But I think it is important to point out that
our society doesn't seem to lack the clarity, knowledge or common sense to come up with good proposals, as this blog shows. It seems more like we have lost the political
ability to get things done properly.


I believe AaronS's solution is the least likely to be imposed but the most likely to be successful.

Bobby G

I'm with Brett (#9), getting the meddling govt out of the private markets is one of the best ideas listed.

I think there are some other great points above, of course, namely increased transparency for banks and risk-assets. Transparency is a necessary and good thing for any functioning private market. Increased accountability is also important, but not only for CEOs... it should be for the clients as well. Not having 100% transparency... that should be assessed as a risk. Putting money into something when the details are not crystal clear is a risky venture! If you are risk-averse you won't do it. If lots of people do it, and lose, fewer people should do it in the future since it is not a wise investment... that's a free market solution that doesn't require tax breaks and bailouts and media jockeying and blaming things on predecessors... oops sorry went on a tangent.

Ultimately I still think (and have thought for over a year now) that the mortgage-backed securities crisis was not caused by deregulation but by bad regulation in the first place. F&F were taxpayer backed... that's bad. Sure we had risk limits on them to try to get them to act like a private firm but as govt officials got "greedy" for good reports, they started alleviating the risk limits, and naturally F&F (themselves accountable for nothing) would buy up anything they could, which caused everyone to think that there was value in any mortgage-backed security because F&F would always buy it. These risk limit removals were condemned as "deregulation" when in fact if there were no regulation to deregulate in the first place there wouldn't have been a problem!

...Hence my agreement with Brett (see I bring my comments full circle sometimes).



Glass Steagall seems like one of the most logical pieces of legislation ever passed, and yet, it's gone.

It's not draconian big government. IF you want the government to insure deposits with FDIC, THEN you can't also be an investment bank. Therefore, if you do not meet the requirements, you must tell all depositors that their accounts are not FDIC insured.
I think you could add on to that a limit of how many FDIC ensured accounts you can have, and put an end to too big to fail in a heartbeat. As far as the citizenry is directly concerned, anyway.

How Glass-Steagall ever got repealed blows my mind.


why not just remove the middlemen. Nationalize the banks and, in mr. krugman's charming words, wipe out the shareholders including the millions who invest in IRA and 401K retirement accounts. then our smart little president will have even more money with which to choose winners and losers in his new industrial policy.


Change the capital gains on stocks to be highest for the shortest holding times, 30% for less than a day, 25% for less than a week, 20% for less than a month, 10% for less than a year and 0% for anything held for more than 5 years.

Reward long term investing and punish the speculators.

Mario Bosh

Most so called profit of Wall street are questionable, I would arrested the top 5 officals of Goldman Sachs as a starting point

Drill-Baby-Drill Drill Team





There is only one law that is necessary to reform Wall Street, and it already exists. It just hasn't been enforced:

Don't commit fraud.

If people are involved in a voluntary transaction, with full knowledge of all risks, the government should not be involved. If those risks bite someone in the rear, they suffer the consequences - not the taxpayer.


Since high-frequency trading is opaque to regulatory analysis because of speed, timing, unclear ownership, and volume, it is certain to be largely fraudulent.

Other than systematic fraud, how can all the big players show inexorable daily profit if they are simply playing against each other? It is either fraud, or a pointless hidden tax on the market, skimmed by the trading programs.

1) Open source the (anonymized) trading datasets, and cut the contributing analysts (say, underemployed grad students or programmers) in on the fines generated by SEC prosecution of any abuse, including any "errors" of trade ownership. I'll bet lots of ownership relationships will be inferred by the analysts when they see certain stable trading patterns...

2) Arrange capital gains tax on a scale that diminishes from a very high rate on very short security holding times, to zero after 5 or 10 years. A security held for less than 100 milliseconds should have any capital gains taxed at more than 95%. Five minutes at 80%.