In the aftermath of the acute phase of the Great Financial Crisis, the Obama Administration trotted out the bank lobbyist written Dodd-Frank Act.  Not surprisingly, it didn’t fix the financial system and made the plague of too many ineffective regulations even worse.

At the start of Trump’s second term, his advisors are asking what can they do to fix the US financial system and at the same time eliminate as many ineffective regulations as possible.

Fixing the financial system requires adopting “Intelligent Regulation”.

Intelligent regulation starts with transforming the Federal Reserve from a capital “C” Central bank to a small “c” central bank.

This transformation involves three steps:

1. Stripping the Fed of its monetary policy role and returning this role to the Treasury where it belongs;
2. Stripping the Fed of all of its supervision/regulation roles and transferring these roles to the FDIC.  Given the FDIC is the only regulator who can close a bank, consolidating supervision and regulation with the FDIC reinforces market discipline on the banks.
3. Expanding who can have an account at the Fed to every US citizen, US company, US partnership, US trust, US investment fund, US governmental entity … .

It is the third step that puts the small “c” central bank into the Federal Reserve.  When everyone has an account at the Fed, it truly is a “central bank”.

Please note, you can think of the account as an interest bearing checking account.  The fact you have an account at the Fed does not mean you have to keep any or all of your money there.  However, by law, the account should pay the higher of the 90-day Treasury bill rate or 2%/year.

Transforming the Fed has three significant advantages:

1. It ends Too Big to Fail.  It is the Fed accounts that are the critical, must always function part of the payment system.  Since these accounts are independent of the banks, the failure of a bank doesn’t threaten the payment system.
2. It reduces costs for everyone who uses the payment system.  It does away with all the fees charged by banks and delays in allowing an account holder access to their money.
3. It removes from the Fed responsibilities it has shown it is not fit for purpose to have while at the same time emphasizing what the Fed actually does well.

Intelligent regulation goes on to transform the FDIC.  It makes the FDIC the sole regulator responsible for bank supervision/regulation.  This allows the FDIC to make explicit the tradeoff between disclosure and a dramatic reduction in regulation.

To qualify for deposit insurance, a bank must disclose at the end of each business day its current exposure details.  We live in the Information Age and with the advances in Artificial Intelligence it will be easy to assess the risk each bank is taking.  This in turn lets investors (including other banks) exert market discipline on each bank’s management to minimize the bank’s risk profile.

The FDIC can also take advantage of the investors exerting market discipline.  The investors will identify which banks are in trouble and what the problems are.  This dramatically improves the quality of supervision.

Investors have an incentive to do this as the FDIC will be required to close any bank who approach insolvency.  Closing the bank will likely result in the investors incurring losses.

Given the trigger for closure is approaching insolvency, there is no reason for most of the regulations introduced under Dodd-Frank or for regulations involving bank capital.