During the last year we have witnessed a government takeover of Fannie Mae and Freddie Mac, the collapse of investment banks Bear Stearns, Lehman Brothers and Merrill Lynch, the disintegration of insurance giant AIG, and the disappearance of hundreds of banks including major institutions like Wachovia, Washington Mutual and Bank United.
Add to this the billions stolen through a decade-long Ponzi scheme conducted by a highly visible Wall Street maven and you would expect almost universal demand for a complete overhaul of the financial regulatory system. Instead, a worldwide financial crisis has required trillions of dollars in government obligations to prop up a financial system managed by essentially the same regulators and executives that created the storm that bankrupted the system. Meanwhile, millions have lost their jobs, their homes and a good portion of their life savings as a result of the excesses and ineptitude that has come to light.
As with TARP, the stimulus bill and healthcare reform, the Obama administration’s initial financial regulatory reform proposals are moderated in an effort to attract bi-partisan support and a consensus for action. The focus of the financial regulatory proposals under consideration relies on the identification and containment of risks that could lead to a systemic economic meltdown.
Mortgaging The Future
The excesses and abuses of borrowers and lenders alike helped fuel the unfettered growth of too many institutions that were deemed to be too big to fail. These factors, combined with complex and opaque transactions promulgated by the largest institutions in order to leverage unsustainable growth led to the perfect financial storm.
As a result governments around the world have been forced to borrow from the future in order to preserve the current order and thereby reinforce a moral hazard that could lead to a repeat of the current crisis. In fact under the current scenario many of the institutions that helped create the storm will wind up bigger, stronger and more dominant players in the industry thanks to timely and pervasive government assistance.
The Obama administration proposals will attempt to manage this situation through increased oversight. However, can the systems and people who failed to detect and expose something as obvious and elementary as the Madoff Ponzi scheme be relied upon to detect the risks embedded in these big and powerful institutions?
If an institution is deemed to be too big to fail, should it be allowed to take risks that primarily benefit its managers and short term arbitrage investors, like hedge funds who bail out early and leave the taxpayers with the tab? Or should they be managed and regulated like a public utility with allowable risks measured against specific measurable public outcomes?
The publicly-oriented reform proposal to establish a Consumer Finance Protection Agency to regulate the provision of loans to consumers is being vehemently opposed by the industry giants. Since American consumers are such an integral part of the world economy, shouldn’t we be concerned with their financial health and stability?
The industry claims that too much regulation will inhibit growth and innovation, and they are right. However most of the sustainable growth in our economy has come from less dominant firms seeking increased market share and from firms and investors that are willing to bear the risk and rewards of success and failure that comes from true innovation.
I am not sure about the precise balance between regulation and innovation, but I am sure that we should not have institutions that are simultaneously too big to fail and too big too regulate.
