Obama’s Financial Push Misses the Boat
Liz | 04/23 at 01:06 PM
Remember the old Rolaids commercial: “How do you spell relief”? An entire generation grew up thinking the answer was: R-O-L-A-I-D-S. Democrats have produced a new source of confusion: “how do you spell reform?” Answer: THOUSANDS OF PAGES OF BEWILDERING BUREAUCRACY.
President Obama stormed Wall Street’s gates yesterday, demanding quick passage of measures he promises will prevent further financial crises. Just as in the healthcare debate, the politically motivated rush to judgment is a mistake.
For sure, we need to overhaul financial regulations. (Have you noticed how “financial reform” has become “Wall Street reform”? Just as he attacked insurers to ram through healthcare, Obama has demonized greedy fat cat bankers in his quest to change the rules. It’s so much easier when it’s personal.)
First and foremost we need to assess the findings of the Financial Crisis Inquiry Commission, to see what went wrong. That was the brief given to the bipartisan group currently holding hearings into the cause of the collapse. Unfortunately, they are not due to report out until December 15 – way past the due date for our accelerating president. The Commission folks might as well pack it in and go home. It seems the Dems have all the answers they need.
Flying on one wing, as it were, and without the benefit of considered analysis, Senator “Friend of Angelo” Dodd has put together a smattering of changes and regulations that get at some of the causes of the financial meltdown, while leaving aside some of the most problematic. Left off the list is any effort to reconsider the role of Fannie Mae and Freddie Mac, explicit caps on leverage, and changes in how the ratings agencies are compensated. Most unfortunate, perhaps, is that Dodd et al chose not to effect politically difficult changes to how we regulate our financial markets. As financial products proliferated over the decades, our supervisory framework became as overstuffed with commissions and bureaus as your grandmother’s attic, allowing financial firms to pick and choose their regulator.
By far the greatest distortion caused by this historical cobbling is that the Senate Agriculture Committee oversees the extremely sophisticated derivatives industry. The committee is concerned with issues such as school lunch programs and relief payments for farmers. That they are also charged with keeping tabs on credit default swaps stems from the early days of the futures markets, where farmers traded pork bellies and soy bean futures to manage their incomes. Time has moved on; figuring out derivatives trading today could challenge a nuclear physicist.
To her credit, Committee Chair Blanche Lincoln has put forward some of the toughest regulatory changes under consideration, and some of the most useful. Among other things, she calls for all financial derivatives to be traded on exchanges and cleared through clearing houses. These measures would provide more transparency in the markets, and presumably would reduce the risk of virus-like failures. Given the long-reaching tentacles of the credit default swaps created during the boom, and the gigantic amounts of money involved, these proposals seem sensible, though hard to achieve. Already numerous industry participants are arguing that their particular niche should be granted an exemption; undoubtedly, too many “carve-outs” will occur, reducing the impact.
A corollary issue here, which Ms. Lincoln does not address, is whether a financial firm should be allowed to issue or trade credit default swaps on bonds in which they have no interest. (You’ve probably heard the comparison to owning fire insurance on your neighbor’s house; your spirits lift at signs of smoke next door.) I tend to think there is no virtue in these instruments but I’m sure that traders would think otherwise. In any case, while some of Ms. Lincoln’s proposals are excellent, she really should not continue as the chief regulator of these products. Rather, this responsibility should have been merged into the SEC, as lame as it has been in recent years, which is responsible for other trading oversight.
Instead of streamlining regulation, Dodd’s bill plops down an entire new agency – the Consumer Financial Protection Bureau – right in the middle of the Federal Reserve. This outfit has a nice Main Street ring to it – consumers want to be protected, of course. However, that’s also the job of the FTC, and states’ attorney generals. A review of the proposal from consumer advocacy group National Community Reinvestment Coalition argues the point. CEO John Taylor writes, “while the Bureau may write rules for all financial institutions, consider the hurdles it has to jump….We counted no less than ten in a gauntlet of barriers that make it difficult to approve consumer protections.” Some may celebrate the encumbrances; I think the ever-thicker clog of regulation depressing.
The proposals on the table miss the most obvious issue: excess leverage. As WOW readers know, every financial crisis in the country’s history has issued from one simple behavior: borrowing too much money and betting wrongly on a “sure” thing. In this past downturn the sure thing was that housing prices would not drop. They never had, went the argument, so they never will. When funds leveraged holdings of securities 30 to one based on that certainty, the end was near.
Though the Dodd bill tiptoes towards more rigorous capital requirements and leverage limits, this should be the main thrust, along with reining in the proliferation of derivatives.
I am disappointed that those at the Fed whose loose money decisions allowed the U.S. real estate bubble to dangerously expand, those in Congress like Barney Frank who mandated that Fannie Mae extend credit to unworthy borrowers, those at the ratings agencies who were complicit in misrepresenting the value of securities and those who lied about their income to secure loans they couldn’t afford have been forgotten in our haste to make sure none of this ever happens again. Here’s a promise: it will happen again. We will have future bubbles, and future recessions. Somewhere, even now, there is an investor – maybe in China or perhaps in Milwaukee – hawking an idea that “can’t fail.” If they bring it to you, run for the hills. Do not under any circumstances imagine that Dodd, or Obama or Blanche Lincoln for that matter, is going to protect you.