Ravi Jagannathan’s stance on bank regulation reflected in new proposal by President Barack Obama

2/1/2010 - Last month, President Barack Obama unveiled a proposal to rein in the U.S. banking sector. Drafted by Paul Volcker, the former Federal Reserve head and chairman of Obama’s Economic Recovery Advisory Board, the plan included measures to constrain the growth of the biggest banks and to force those banks to drop hedge fund, private equity and proprietary trading activities. The plan is expected to be incorporated into new legislation within six months.

That aligns with the ideas of Ravi Jagannathan, the Kellogg School’s Chicago Mercantile Exchange/John F. Sandner Professor of Finance and co-director of the Financial Institutions and Markets Research Center. Jagannathan made a similar proposal in his article “Avoiding the Next Crisis,” which appeared in the July 2009 issue of The Economists’ Voice. (He also addressed this issue in the article “What Caused the Current Financial Mess and What Can We Do About It?," which appeared in the November 2008 issue of Kellogg Insight and in a special issue of the Journal of Investment Management.)

The article, co-authored by John H. Boyd, the Frederick Kappel Chair in Business & Government Relations at the University of Minnesota’s Carlson School, cautioned against banks that are “too big to fail” because of their potential to harm the economy if they stop working. Jagannathan and Boyd proposed a two step “cure” for this problem, which included enforcing a size limit for banks and defining firms that perform critical banking functions (i.e., mortgage originators or insurance firms) as banks, subject to regulation.

“Most current proposals, including those emanating from Washington, leave the TBTF [too big to fail] problem untouched or worsen it by encouraging financial consolidation,” the article stated. “It is time to recognize that big banks, like big munitions factories, can produce big negative externalities.”