Marketplace Scratch Pad

Regulation Reaction

Scott Jagow Jun 17, 2009

I find this debate over financial regulation fascinating, so I’ve been scouring the web for a variety of viewpoints on the administration’s plan. The three hot points seem to be: giving the Fed more power, the creation of a consumer protection agency for financial products and who gets the blame for the financial crisis.

Let’s start with the last one. Here’s what President Obama said in his speech today:

It is an indisputable fact that one of the most significant contributors to our economic downturn was an unraveling of major financial institutions and the lack of adequate regulatory structures to prevent abuse and excess. A culture of irresponsibility took root from Wall Street to Washington to Main Street. And a regulatory regime basically crafted in the wake of a 20th century economic crisis — the Great Depression — was overwhelmed by the speed, scope,
and sophistication of a 21st century global economy.

But was it the regulatory structure or the regulators? The Center for Economic and Policy Research has this take:

The basic story of this crisis was not that the regulatory authorities lacked the ability to rein in this disaster before it was too late. Rather, the regulators – most importantly the Fed – opted not to use their power to rein in the housing bubble.

Former Fed economist Arnold Kling reacts this way:

Both the President and the white paper blame this excess leverage on greed and faulty compensation structures. What about taxes and subsidies? Our high corporate tax rate, along with the deductibility of interest for corporations, encourages corporations to look for ways to minimize equity financing. For individuals, government-subsidized mortgages and the tax deductibility of mortgage interest help to encourage over-leveraging.

Rep. Jeb Hensarling, the highest ranking Republican on the House Financial Services Committee:

The White House plan will create “a bailout nation,” says Hensarling in a statement. The congressman says the administration missed a bet in not including Fannie Mae and Freddie Mac in its financial overhaul. The two loan agencies “are the most significant cause” of the nation’s financial crisis, Hensarling contends.

Instead of adding more financial regulations, Hensarling argues, the president should have streamlined them.

Let’s move on to giving the Fed power as a “super-regulator”. Members of Congress, on both sides of the aisle, are dubious about this:

Senate Banking Committee Chairman Chris Dodd (D-Conn) told reporters outside the White House that there are “legitimate questions” about the suitability of giving that job to an agency whose “primary responsibility is monetary policy.” Moreover “there’s not a lot of confidence in the Fed at this point,” Dodd added. “Both Democrats and Republicans are looking for an alternative.”

Mike Shedlock at Mish’s Global Economic Trend Analysis:

Note how increased power is given to the Fed, an agency that did not see this coming and whose premise is that bubbles are best dealt with after the fact because no one can tell bubbles in advance.

The best way to limit appetite for risk is to prevent the Fed from manipulating interest rates to ridiculously low levels. The way to do that is to abolish the Fed, not strengthen its power.

There is quite a bit of support, however, for the proposed Consumer Financial Protection Agency. I think TARP overseer Elizabeth Warren explained the concept quite well when she called for this agency to be created two years ago:

It is impossible to buy a toaster that has a one-in-five chance of bursting into flames and burning down your house. But it is possible to refinance an existing home with a mortgage that has the same one-in-five chance of putting the family out on the street-and the mortgage won’t even carry a disclosure of that fact to the homeowner….

Why are consumers safe when they purchase tangible consumer products with cash, but when they sign up for routine financial products like mortgages and credit cards they are left at the mercy of their creditors?

Former IMF economist Simon Johnson also likes the idea of a consumer protection agency for financial products, but will it happen?

The details are not yet clear enough to see how what will emerge, and we also don’t yet know how vigorously Treasury will defend this idea against the financial sector lobbies. But at least this is something new and potentially powerful in all the right ways.

(Legal scholar Cass) Sunstein, of course, is known for the idea of a Nudge – pushing consumers ever so gently towards better decisions. It’s a fine principle to guide thinking, but lobbies, opponents within the administration, and members of congress with their own agenda will not be moved through gentle means.

This is going to be quite a fight.

Yes, the financial lobbies are already lining up against the CFPA idea. But based on what I’ve read, the financial industry is kind of split on the bill as a whole. From CNN Money:

Some in the banking industry said the new capital requirements appear tougher than they had originally thought.

Jaret Seiberg, a policy analyst with Concept Capital’s Washington Research Group, called the proposal “worse for the financial sector than was expected…”

The Financial Services Forum, which represents 17 chief executives, said overall, the proposal appears “comprehensive” and “reasonable,” said president Rob Nichols.

“I think this is a great start of the dialogue for what’s going to take place on the Hill over the next six months,” Nichols said.

Finally, the Wall Street Journal’s Deal Journal blog points out differences between former Treasury Secretary Hank Paulson’s regulatory “blueprint” from last year and President Obama’s plan:

In some areas, Paulson was more daring. He proposed stricter, federal oversight of the insurance industry. He proposed a federal charter for insurance companies, instead of allowing insurers to choose among different state charters and different regulators. Obama stops short of calling for a national charter.

One big difference: Paulson wanted to create a mortgage commission, headed by members of the Fed and other agencies, to prevent home owners from taking on excessively risky mortgages. Obama wants to expand consumer protection by creating a new agency that not only regulates home loans, but also a wide range of debt, including student loans and credit cards.

Here’s the link to read the entire white paper on the plan.

And if you have some thoughts, please feel free to share them.

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