For more than a year Congress has been talking about reforming bank and other financial-market regulations. The regulatory system certainly needs reform — it broke down badly over the last decade. But not many of current proposals are useful.
In particular, the financial-regulation bill being sponsored by Sen. Chris Dodd (D., Conn.) will add more to Washington’s power and bureaucracy without fixing core problems.
For starters, the bill doesn’t encourage much-needed loans to small businesses. How many years have to pass before Washington wakes up to this problem?
Bank lending is being constrained by the application of arbitrary valuations to bank assets and regulatory capital, along with the hesitation of regulators to use their authority to assess capital adequacy. The result is that banks are piled with cash while small businesses are cut off — which means small firms end up holding back on inventory and hiring while start-ups never get off the ground.
The Dodd bill also does not address the huge advantage big banks have over the smaller banks that make many of the small-business loans.
It also doesn’t speak to needed adjustments in the recently passed credit-card bill. A supposedly well-meaning provision in this legislation restricted future rate increases on outstanding credit-card balances. But this had a predictable effect: Banks raised rates preemptively, making an important source of funds for small businesses prohibitively expensive. Will the Dodd bill undo this portion of the credit-card law? Don’t hold your breath. When Congress legislates in haste, it often causes more problems than it solves. But Congress rarely reconsiders its mistakes.
The Dodd legislation also does little to resolve the giant mortgage mess still facing Washington and the economy. Fannie Mae and Freddie Mac, which are losing billions of dollars each quarter, are unresolved in the bill. They’re not even counted in the budget deficit or national debt, even though they are clearly borne by taxpayers.
The losses on loans made prior to the financial crisis project to be in the range of $600 billion or more, and new mortgage renegotiations are adding to that amount every day. These losses dwarf the taxpayer losses from the bank rescues and TARP, yet Congress won’t touch the Fannie/Freddie problem because it exists inside the Beltway. In other words, the Fannie/Freddie money trail points straight back to Congress.
Another pressing problem is the regulation of derivatives. The Dodd bill addresses this, but in a way that may further delay the solution. Existing agencies have the power to regulate these critical markets, but they aren’t doing the job, and the Dodd legislation provides cover for more of the same. Lost in the shuffle is aggressive transparency for counterparty positions, which has been needed for years, along with differential capital requirements that take risk into account but don’t regulate where trading takes place.
This is not to say the Dodd bill is too small. It’s big, but misguided.
The legislation creates a mega-fund in Washington responsible for bailing out not only banks, but insurance companies and other non-bank entities that don’t take deposits. In the guise of fixing the too-big-to-fail problem, this will make matters worse. It will convince markets that Washington has plans to conduct bailouts beyond the banks, and markets will interpret this as a green light to leverage up banks and non-banks as much as possible.
Why not deem the whole economy “too big to fail,” have the government do all the borrowing for everyone, and then divvy everything up? Oops, that’s exactly the direction we’re heading.
The assumption that Washington could and would resolve Lehman Brothers without a bankruptcy, as it had Bear Stearns, was the single biggest mistake in the series of mistakes in 2007 and 2008 that led to the financial panic and the ensuing epidemic of job losses. But new proposals out of Washington only reinforce the old pattern: A scenario is being created in which a major company is able to sell way too much financial product, drawing on underpriced loans in a market lulled into overconfidence by Washington’s protective umbrella.
The Dodd bill does propose a big new government department inside the Fed to protect the consumer from banks and bad financial products. But the Federal Reserve System is already overburdened with regulatory duties, and it’s a mistake for Congress to assign it yet another complicated role.
Rather than creating a new oversight department that expands Washington’s regulatory power, it would be better to use this opportunity — per the Obama administration’s notion of not letting a crisis go to waste — to streamline and concentrate the many existing consumer financial regulators in one place. This would result in a reduction of government jobs, rather than the big increase that is going on now.
Sen. Dodd is also proposing a Treasury-run regulatory oversight committee to assess risks within the global financial system. Fine, but this was the responsibility of existing agencies before the crisis. It’s unlikely that further guidance from Congress will reduce the odds of a new mega-mistake.
One of the biggest gaps in the bill is that it doesn’t address the role that the Fed’s super-low interest rates played in adding to global leverage. The Fed staked its credibility on 1 percent rates and then limited its rate hikes as the economic expansion progressed. This caused savers to subsidize borrowers, which is the reverse of what should have been happening. And now the identical problem is starting again, with the same actors assigned to watch out for damage and distortions.
By focusing on the wrong problems, the Dodd bill would make the economy worse, meaning the private sector will not be able to create the jobs the U.S. economy needs. At the same time, state and local governments won’t collect the level of tax receipts needed to pay pensions and operating expenses.
Economic and job growth require good financial regulation, proposals for which are few and far between in Washington today.
– David Malpass is president of Encima Global.