The Regulator Guys

The Obama Administration’s new Financial Regulatory Reform plan hit the streets yesterday.  At 85 pages, it’s a lot to digest.  Today’s Washington Post has pretty good coverage, including this excellent summary chartJoe Nocera of the New York Times has some pointed criticisms, the gist of which is that Obama’s reforms, unlike FDR’s, do not go far enough.

Probably the biggest step forward is that the plan calls for giving someone the authority to close and liquidate insolvent financial behemoths like AIG and Citigroup.  Right now, the FDIC can shut down failing banks, but nobody can do the same with financial supermarkets like AIG and Citigroup.  In a similar view, it also empowers the Fed to oversee huge, systemically important financial institutions and require them to hold more reserves and take fewer risks.  Both of these changes seem to go a long way toward resolving that tension between moral hazard and “too big to fail.”

Another step that looks welcome is the establishment of a Consumer Finance Protection Agency, along the lines suggested by the estimable Elizabeth Warren, the Harvard Law Professor who chairs the Congressional Oversight Panel that monitors the TARP bailouts.  In this 2004 interview with Bill Moyers she offers a critical, detailed assessment of credit-card-company abuses and sensible ideas for reform.  Her two-part interview with Jon Stewart this past April is worth watching as well.  Warren has been rumored as the person to lead this new agency.  Had an effective consumer protection agency been in place earlier this decade, we might have avoided the stampede into dubious adjustable-rate mortages and option ARMs.  Not surprisingly, the financial services industry is critical of the idea of such an agency.

Regulation of hedge funds and credit default swaps (CDS), including an organized CDS exchange, also looks sensible.  Nocera counters, however, that the CDS exchange would include only standardized, “plain vanilla” derivatives, not the customized “bespoke” derivatives that were at the heart of the meltdown.

Many had been pushing for consolidating the myriad financial regulatory agencies into one, so as to eliminate “regulatory arbitrage,” by which financial institutions could pick their own regulator, generally whichever was either weakest or coziest.  The new proposal doesn’t do that, but it does consolidate considerable authority in the Federal Reserve, with a council of regulators to advise the Fed.  The proposal apparently does not spell out which, if any, of the redundant regulatory agencies will be eliminated, though a Post article mentions that Obama wants to eliminated the feckless Office of Thrift Supervision, which incredibly was the regulator of AIG, the world’s largest insurance company.

Is it a good idea to vest that much regulatory authority in the Fed?  While the Fed is more independent than any of the executive branch agencies, that also means it’s less accountable.  The Fed missed both the stock- and housing-market bubbles and its previous chair, Mr. Greenspan, was basically hostile to the idea of financial regulation.  As Dean Baker points out, it’s ultimately the quality of the regulators, not the regulations, that matters:

‘The Obama administration’s regulatory reform proposal includes many positive features, but it ultimately will not make the financial system safer for the simple reason that it conceals responsibility rather than holding regulators accountable for their failures. 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 basic story is that the regulatory authorities — most importantly the Fed — opted not to use their power to rein in the housing bubble. . . .

‘Politicians and regulators have a direct interest in portraying the crisis as being the result of an inadequate regulatory apparatus rather than failed regulators, because failed regulators should get fired. However, by not holding failed regulators accountable, this reform proposal is setting the grounds for the next crisis.

‘Even a perfect regulatory structure will not work, if the regulators do not do their job. They will not have an incentive to do their job, if there are no consequences for not doing their job.

‘In this case, we have seen the most disastrous possible regulatory failure — this is like the drunken school bus driver who gets all his passengers killed driving into oncoming traffic — and no one is held accountable. The message to future regulators is therefore to simply go along with the powers that be (i.e. the financial industry) and you will never suffer any negative consequences.’

(Now, how exactly could the Fed have reined in the housing bubble, other than raising the federal funds rate?  Baker has written elsewhere that the Fed could and should have noticed the surge in adjustable-rate subprime mortgages around mid-decade and called attention to them.  Even if the Fed did not have power to crack down on predatory lending/borrowing [take your pick] it could have asked Congress to take action or to give it such powers.  I doubt the Fed would have gotten anywhere with that, which is why a Consumer Finance Protection Agency makes a lot of sense to me.)

Notable and quotable:

Congressman Barney Frank:

‘We are going to abolish, I hope, the Office of Thrift Supervision [OTS].  AIG and some others that were theoretically regulated by OTS, that was like being regulated by the meter maid.’

Post reporters David Cho and Zachary A. Goldfarb:

‘On May 8, lobbyists representing many of the nation’s banks and hedge funds huddled with senior White House advisers in the Roosevelt Room, seeking to snuff out an administration plan to increase the Fed’s authority to regulate them, when Treasury Secretary Timothy F. Geithner stuck his head in the door.

‘Fresh from meeting with Obama, Geithner asked the lobbyists what they were up to. When they explained they preferred that a council of regulators, rather than the central bank, safeguard the financial markets, Geithner silenced the discussion with a string of obscenities, according to people who were present.’

Huh? The Beav cusses up a storm? There’s surely more to Geithner than we know, but I think it’s safe to say he’s not this guy:

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