Roubini's radical plan to reform the financial system

Filed in archive markets on May 11, 2010

Dr Doom Nouriel Roubini says Obama's financial reforms don't go far enough. They won't fix the market and will nto stop another meltdown from happening again.

Writing in Newsweek , Roubini says it's time to break up the big banks like Citigroup and Goldman Sachs. "Not only are such firms too big to fail, they're too big to exist, and too complex to be managed properly,'' Roubini says. "They should be pushed to break themselves up."

He says the problem with the reform measures now is they create moral hazard. "This approach generates moral hazard on a grand scale. Investors now have every reason to conclude that central banks will do nothing to stop a speculative bubble from growing-and in fact may even encourage it, becoming cheerleaders for the "new economy" or the virtues of homeownership-but will do everything in their power to limit the damage. This is extraordinarily problematic. If investors believe the Fed will save them, they'll take even more risks the next time around."

He says one way to bust up the banks is to impose higher "capital-adequacy ratios,", forcing these institutions to hold enough capital relative to all the risks posed by their different units. That would reduce profits.

Another way is to reintroduce the Glass-Steagall Act which was introduced during the Great Depression to separate commercial banking from investment banking. That was abolished by President Bill Clinton when he was sucking up to financial markets and effectively led to the meltdown. Roubini says it should not be only reintroduced but that it should be made even tougher, prohibiting all banks-including investment banks-from practicing any kind of risky, and for that matter sneaky proprietary trading which is filled with conflicts of interest and also prohibiting them from doing any risky short term borrowing.

It's a radical plan. But will the Obama administration have the stomach for it?