Business Books: 'Insiders' designed failure for financial reform

NEW YORK (Reuters) - The bitterly fought overhaul of U.S. financial regulation is supposed to prevent another crisis. It won't, says respected finance professor and former trader Amar Bhide.

Bhide, who gained attention in 2008 with a contrarian view of the role technology plays in competition among countries, argues that modern finance must change far more drastically than regulators envision before Wall Street is safe again.

For one, the assumption that financial innovations should be allowed to grow unchecked is wrong, he says. And yet one of the goals of financial regulation is to avoid stifling such innovation.

In "A Call for Judgment" (Oxford, $29.95), Bhide takes aim at some notorious characters from the 2008 crisis, such as credit default swaps and loan securitization.

Financiers argue that CDSs help hedge the risk of buying a bond. Bhide counters that there are other ways to hedge, like diversification, without taking on the risk of CDSs.

Another target is the packaging of loans into securities, which he says has allowed financial giants to remove themselves further and further from borrowers, and therefore from the responsibility to lend only to those who can afford to borrow.

Bhide, a professor of international business at Tufts University, also wrote "The Venturesome Economy," which drew praise for challenging the notion that advanced economies must innovate to stay ahead. Instead, they simply have to make the best use of existing technology, he argued at the time.

"INSIDERS" VERSUS "INFORMED OUTSIDERS"

In his latest book, he rails against financial "insiders" for rendering impotent the financial overhaul passed by Congress earlier this year.

One of these so-called insiders is Yale University economist Robert Shiller, a tireless defender of financial innovation, even after the 2008 financial crisis.

Bhide says Shiller and others who advised lawmakers when they were writing the new legislation failed to question the basic assumptions of modern finance closely enough.

In the other camp, who Bhide calls "informed outsiders," are former Fed Chairman Paul Volcker and Bank of England governor Mervyn King, both of whom argued that commercial and investment banking should be separated again. Or, in King's words, utility banking must be separated from casino banking.

The overhaul passed by Congress puts constraints on big banks using their own money to make financial bets, and establishes a consumer protection agency. It also gives the Federal Reserve more regulatory power and sets up a council to identify systemic risk in the financial system.

Indeed, Fed Chairman Ben Bernanke and other regulators -- who outline their plans for implementing the new legislation before a congressional panel on Thursday -- have considerable leeway.

But whatever the outcome, it will fail to bring about fundamental change, Bhide argues. That's because it was designed by regulators and policymakers who have yet to come to terms with the notion that not all financial innovation is good.

(Reporting by Emily Flitter; Editing by Eddie Evans)