Michael Brush of MSN Money writes a critique of the financial reforms in the House. Here are the ones he says we really need:


The House reform bill

Simply put, a House financial-reform bill approved in December falls short on five of the basics the experts say we need. A sixth might be covered by a new consumer agency, but that proposal could be killed to win Senate approval.
So rather than spend too much time on a bill that will change anyway, let's look at the six key reforms the experts say we really need:

1. Scale back the big banks
Huge banks at some point become "too big to fail," which means they'll get bailed out by the government if they get into trouble. This frees them to take wild risks.
Also, as MIT professor Johnson says in a book due out next month called "13 Bankers: The Wall Street Takeover and the Next Financial Meltdown," large banks have so much clout in Washington that they can block any regulatory changes they don't like.
One fix could be to cap bank size relative to the size of the economy. Johnson also suggests separating "utility" banks that handle the basics such as savings and checking from the "casino" banks that work the market. To get there, we'd need to break up the likes of Goldman Sachs and Citigroup, Johnson says. Another fix would be to increase the amount of capital that banks have to hold to back riskier businesses.

2. Fix the pay packages
Top bankers stand to reap huge rewards from stock options and restricted stock, as well as cash. This sets up distorted incentives. They lose little if their banks go bust but reap big gains if risky moves pay off.
"This creates a real incentive for excessive risk taking," says Columbia Business School professor Joseph Stiglitz, a Nobel Prize winner and the author of "Freefall: America, Free Markets, and the Sinking of the World Economy."
Though federal banking regulators can consider distorted pay incentives when reviewing bank risks, no one in Washington seems ready to deal with this issue.

3. Fix the Securities and Exchange Commission
Much of the blame for the financial crisis lies with the SEC, says William Isaac, who was the head of the Federal Deposit Insurance Corp. in the early 1980s and is now a financial-sector consultant with LECG, a consulting group.
A few key mistakes: The SEC relaxed rules that limited how much banks could borrow and went soft on short-sellers who profit by spreading rumors. It even missed the Bernie Madoff fraud. But nothing in the House bill on financial reform would make any significant changes to toughen this market watchdog.
For the next fiscal year, Obama has proposed boosting the SEC's budget by 12% and adding more than 100 staffers to work on fraud and market-manipulation cases.

4. Streamline banking regulation
As things stand now, too many different regulators at the Treasury Department, at the Fed and elsewhere in Washington oversee our banks. Banks can go shopping for regulators and play them against each other in a game called regulatory arbitrage.
"A lot of the financial innovation wasn't about creating new instruments. It was about regulatory arbitrage," former Fed official Reinhart says. Behind the scenes, big banks have to create dozens of different entities and keep much of their business off their official balance sheets to make it work.
"They aren't too big to fail. They are too complex to fail," Reinhart says. "We need regulatory consolidation."

5. Increase consumer protection
It's easy to blame the financial meltdown on people who took out subprime mortgages for getting in over their heads or signing contracts they should have understood. But that's too simple, says journalist Andrew Cockburn, who takes a close look at what caused the meltdown in a great film called "American Casino."
Plenty of real-estate agents committed fraud by changing the terms of mortgages without telling borrowers or by burying key material in incomprehensible fine print, Cockburn says. Crooked mortgage lenders were able to avoid investigators by regulator shopping -- changing their legal structures so they could be overseen by the most favorable, or laziest, regulators in Washington.
A proposed Consumer Financial Protection Agency, now before Congress, might fix all this by requiring more clarity in the contracts behind mortgages, credit cards and other financial products. But the agency may not survive the Senate. "The Republicans and the industry don't like it, and it is a tough fight," one consumer lobbyist says.

6. Put complex derivatives on an exchange
The meltdown, of course, wasn't just about mortgages. The system blew up because banks and AIG used those mortgages to create complex derivatives that were nearly impossible to value, putting too much risk on their balance sheets.
If derivatives were traded on a central exchange, as stocks are, someone could monitor positions and make sure banks that owned them had enough capital to sustain losses if they blew up. Attempts in the House bill to create a central exchange were watered down, Cockburn says.