Howard Rich's Blog

June 29, 2009

Largely Useless, Even Harmful

The blunt truth is that even if we had had President Obama’s financial regulatory “reforms” in place four years ago–reforms designed to prevent another financial meltdown–we would still have experienced a horrific economic disaster. In other words, the Administration’s prescriptions deal with the symptoms–and those badly–not the underlying causes.

The astonishing housing bubble could not have happened without the Federal Reserve’s easy-money policy, which got under way in late 2003. If not for the excess liquidity created, there would not have been sufficient fuel to distort the housing market and ultimately the financial system. Yet President Obama has remained mum regarding the need for a strong and stable dollar. Without such a policy it’s guaranteed we’ll continue to experience financial turmoil.

The Fed’s punishment for its wretched doings is that Congress will likely give it more regulatory powers. That’s the thing about government: The more it fails, the more power it accrues.

To respond to criticism that the Fed is becoming too powerful, the Administration is proposing that the Fed get permission from the Treasury Department before it takes “drastic” action to stabilize the economy. Hamstringing or inhibiting such vigorous action is ludicrous. The Fed should respond to panics in the same way we respond to natural disasters: Take immediate, overwhelming action, then pull back as the crisis recedes.

Right up to the government takeover of Fannie Mae and Freddie Mac in September, Congress resisted substantially reforming those two giants, which together guaranteed, repackaged and sold to investors around the world more than $1 trillion in junk mortgages. Significantly, the Obama proposals do not address what to do about Fannie and Freddie.

The bursting of the commodities and housing bubbles would not have threatened the very existence of our financial system had it not been for the perversity of mark-to-market accounting rules. This concept, enacted in 2007, turned the economic equivalent of a serious flood into a tsunami by relentlessly destroying the ostensible value of our banks’ regulatory capital. It was no coincidence that once Congress made it clear in early March that it wanted substantial and quick reform of mark-to-market accounting that stocks–especially those of banks and life insurance companies–vigorously rallied from their recession lows. Mark-to-market accounting should be prohibited just as it was from 1938 to 2007. Again, the White House remains silent.

There’s also no word from Obama-ites about reinstalling speed bumps to short-selling. The SEC has yet to reinstate the uptick rule, nor has it provided guidance on how it will enforce already existing laws against naked short-selling.

Credit-rating agencies? Other than more “disclosure,” no change in their government-sanctioned, cartel-like privileges has been proposed.

The White House has ignored the problem of how to deal credibly with institutions now regarded as “too big to fail.” If this elephantine issue of moral hazard isn’t resolved, additional destructive distortions will arise.

New rules and agencies also can’t eradicate the fallibility of human judgment. The Bush Administration’s response to the unfolding crisis was wildly inconsistent. It saved the operations of Bear Stearns, yet months later allowed Lehman Brothers–an institution of far greater significance–to go under, then within mere hours reversed itself again in regard to AIG. Of course, banks are the most heavily regulated sectors of the economy, yet all that oversight didn’t avert disaster.

What about Obama’s proposals themselves? The new consumer protection agency will have to justify its existence by meddling more and more in financial institutions under the guise of protecting we the people. This will be a damper on innovation. New consumer products–or new anything–always bring with them unintended consequences, especially when they are misused or overused. Thus, this agency will find it suffers less political heat if it stands in the way of innovation.

Commercial paper became the rage in the 1960s as a means of borrowing short-term money and saving interest costs by bypassing the banks. The market blew up when Penn Central went under in 1970, precipitating a serious financial crisis. Thankfully, no agency or regulator was around then to ban commercial paper, even though it had momentarily become a weapon of mass destruction. Instead, the markets came up with the right reform: Such paper had to be backed by ironclad lines of credit from commercial banks. The markets rebounded to higher levels than before.

Would money market funds, which technology made possible in the 1970s, have proliferated if such an agency had been around? Banks would have lobbied intensely to kill the concept in fear that such funds would draw off deposits. The innovation of allowing customers to write checks on their money market accounts would also never have been allowed.

The new consumer protection agency will also be tempted to square circles. Congress is not touching the Community Reinvestment Act and subsequent government decrees mandating that banks grant mortgages to unsound borrowers. Such an agency will thereby be tempted to mandate that credit be extended in accordance with that act, which will lead to future losses.

The White House regulatory plan will also effectively put the kibosh on so-called industrial loan companies–banks created by outfits such as Target and Harley-Davidson to provide credit and other financial services to their customers.

The one sensible idea the Administration has had was put on the table several months ago–the creation of clearinghouses or exchanges for credit-default swaps. In fact, this should be the fundamental core of regulatory reform: transparency. Authorities–and the markets–could then impose proper rules regarding collateral and capital.


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