Just last weekend, in discussing the current financial crisis with friends, I expressed concerns that in the panic to unfreeze the credit markets and stabilize the economy, our government would continue to simply throw money at the problem, while ignoring the systemic changes that must take place to prevent this credit crunch from reoccurring in another form some ten years down the road (anyone remember the S&L Scandal?). I likened the government bailouts, TARP funds and even early legislation, like the Helping Families Save Their Homes Act, to mere tourniquets to stop the economic bleeding, when what the financial system really needed was reconstructive surgery.
Just days later, the Obama Administration unveiled what the President called “a sweeping overhaul of the financial regulatory system, a transformation on a scale not seen since the reforms that followed the Great Depression.” And while the fact that lawmakers, financial institutions and consumer groups are already challenging the plan comes as no surprise, I share their concerns that this plan is more like a series of band-aids than a skeletal fortification for the financial system.
News of the plan first broke on Monday, when secretary of the Treasury Tim Geithner and National Economic Council director Lawrence Summers jointly published an op-ed piece in the Washington Post, entitled, “A New Financial Foundation.” The article outlined the plan in broad strokes and stated that, “[t]he goal is to create a more stable regulatory regime that is flexible and effective; that is able to secure the benefits of financial innovation while guarding the system against its own excess.” On Tuesday, President Barack Obama released an 88-page document detailing the plan, which he introduced in a speech to industry executives and senior officials in the East Room of the White House on Wednesday.
The plan is ambitious in scope, if not in depth. It addresses virtually every sector of the financial industry, including derivatives, mortgages, capital requirements, insurance companies and hedge funds. The most welcome components from my perspective are also among the most obvious. The plan requires lenders to retain a percentage of the loans they originate, in an effort to ensure that lenders are properly incentivized to originate quality loans instead of simply selling off the loans and transferring the risk to third parties. As I’ve discussed in the past, forcing lenders to have some skin in the game is essential to an effective securitization market, but the question remains whether a mere 5% will be enough to do so (not to mention the question of whether the lender’s 5% will be representative of the overall pool).
Another necessary, if somewhat obvious proposal, is to merge the functions of the Office of Thrift Supervision into the Office of the Comptroller of the Currency. This consolidation has been explicitly recommended by watchdog organizations such as the Center For Responsible Lending and hinted at by the Office of the Inspector General at the Department of Treasury (see my prior post on the collapse of IndyMac Bank). While this reform should help prevent “regulator-shopping” and the lax oversight such shopping engenders, the plan stops short of a substantial consolidation of banking regulators, as the Fed, the OCC and the FDIC continue to play various roles in this area.
Which leads me to my greatest concern regarding Obama’s financial overhaul, and the concern generating the most attention in Congress thus far: that the plan bestows upon the Federal Reserve an expanded role of overall risk regulator in the brave new financial world. Wait, you may be thinking, is this the same Fed that kept interest rates unsustainably low throughout the housing boom that fueled the run-up to this crisis? The same Fed that is supposedly “independent” because it is not beholden to the President or the voters, yet evinces a striking proclivity towards protecting certain favored banks at the expense of others in times of crisis? The same Fed that is about as Federal as Federal Express? Yes, that’s the one.
Obama’s plan gives the Fed even broader power and responsibility to police the financial system against the same excesses that it was supposed to guard against and didn’t over the past ten years. The logic behind this move? “The president believes there is not a better way to prevent and manage a future crisis without putting the authority in one place,” said Geithner. “We have to make a choice. I do not believe there is a plausible alternative that provides accountability, credibility and gets to the core of the problem.”
In other words, oversight must be consolidated, and the Fed is, to paraphrase Churchill, the worst option, except for all of the others. The fact that the administration can’t think of anyone better to police the financial system than a group of unelected former bankers who retain close ties to the industry, doesn’t exactly instill confidence. And for those of us who believe the Fed, which subject to few, if any, constitutional checks and balances, already has too much power in our current system of governance, this plan to hand over even more authority to this quasi-private enterprise smacks of both passing the buck on our tough regulatory decisions and dangerously shifting the balance of power in economic regulation and enforcement. I therefore urge lawmakers, when considering Obama’s plan, to consider each of its proposals carefully and on its own merits to ensure that we do not lose this opportunity to make meaningful changes and prevent the next credit crisis from shattering our economic system.