Would you support "real" financial reform?

[Gone4Good]

So what are our congress critters doing.

Yeah, I don't know what the problem is that they're trying to fix here. I suppose there may have been instances where some wealthy people got fleeced, but I haven't heard this is some kind of major problem.**

With respect to the rest of the Dodd bill, I haven't seen much good reporting on it. Everyone is caught up in the Consumer Protection Board and whether the Fed's power will be expanded or curtailed. All side show issues as far as I'm concerned. Beyond that, I haven't seen much of what's in the bill. Hopefully some improvements, but who's to know.


** Timely Edit: There's a story in today's WSJ about how private placement investors are increasingly getting burned. Among the problems cited, the income and net worth requirements to be "accredited" were set in 1982 and haven't been adjusted for inflation. For what it's worth, I imagine doubling them from today's level will roughly return them in real terms to where they were in 1982.

 

[Gone4Good]

Here is a pretty comprehensive article talking about reform.

 

[clifp]

Great article.
I'm in agreement on this part.

The deregulation of the last few decades has come in for a lot of blame for the current financial crisis. It deserves some blame, too. If Citigroup and Bank of America were still operating under the New Deal rules, they might not have flirted with bankruptcy. But take a minute to think about which firms had the biggest problems. They were the shadow banks: stand-alone investment banks like Lehman, Bear Stearns and Merrill Lynch; and other firms, like A.I.G., that were not banks at all. They were never fully covered by the New Deal regulation, and they were not the ones most affected by the deregulation.
The root of the crisis, then, came not so much from the laws that were changed. Finance evolved, and Washington did not keep up. So the creation of another quiet period probably cannot revolve around restoring old rules. It almost certainly depends on new rules, whether they are of the sweeping variety or the more nuanced.

 

[IndependentlyPoor]

They were the shadow banks: stand-alone investment banks like Lehman, Bear Stearns and Merrill Lynch; and other firms, like A.I.G., that were not banks at all. They were never fully covered by the New Deal regulation, and they were not the ones most affected by the deregulation.

Hmmm. I have posted this before, but maybe it is worth repeating here. Perhaps the shadow banks were not the ones most affected by deregulation, but they got some pretty outrageous perks nevertheless.

In December of 2000, the Commodities Future Modernization Act created the Enron loophole, exempting electronic energy trading from regulation. It also exempted Credit Default Swaps from regulation, allowing the AIG Financial Products unit to operate essentially without regulation.

and

In January 2004, the SEC changed the Net Capital Rule to allow Bear Stearns, Lehman Brothers, Merrill Lynch, Goldman Sachs, and Morgan Stanley to operate with unlimited leverage.

 

[Gone4Good]

I'm in agreement on this part.

But remember that "de-regulation" wasn't just about reversing existing rules, it was also about preventing new rules from being imposed on new businesses. It's all of a piece.

 

[Gone4Good]

And it continues . . .

An array of pro-business groups and fiscal conservatives are mounting a well-financed campaign to scale back or block altogether the Democrats’ plan to overhaul regulation of the financial industry. . . . They argue that more government involvement is the problem, not the solution; tightened regulation risks stifles competition; and the plan is fiscally irresponsible.

 

[Gone4Good]

Part of a broad overhaul of financial rules that cleared the Senate Banking Committee last week, the measure would require lenders and companies that package loans into securities to hold at least 5% of the credit risk, though regulators could set lower standards for less risky loans.

Sounds familiar (and good). But not to everyone . . .

Industry officials counter that the requirement that they keep some skin in the game, combined with other regulatory and accounting changes could hinder any recovery in the securitization market. And that could prevent consumer and commercial real-estate lending from returning to normal.

But here's the question. If we define "normal" as pre-crisis normal, do we really want to return there? It seems like we should be aiming for less credit origination than we had during the last boom, even if that means slower near-term growth and a longer path toward full recovery.

 

[ziggy29]

But here's the question. If we define "normal" as pre-crisis normal, do we really want to return there? It seems like we should be aiming for less credit origination than we had during the last boom, even if that means slower near-term growth and a longer path toward full recovery.

I believe "normal" as defined in the post-WW2 economic boom was an unsustainable anomaly. I think it might be wise to assume slower real growth in the decades ahead given all the headwinds faced by the economy -- globalization pressuring wage growth, huge debts, massive underfunded public liabities, fiat money with the printing presses cranked up and the obvious need for higher taxes to climb out of the hole will all exert pressure. And while some of them may be surmountable by themselves, together I don't see how we can pretend it's 1955 any more.

 

[audreyh1]

But here's the question. If we define "normal" as pre-crisis normal, do we really want to return there? It seems like we should be aiming for less credit origination than we had during the last boom, even if that means slower near-term growth and a longer path toward full recovery.

Hey - if we curb lending practices such that we don't have a repeat of the 2005-2007 housing bubble, then these companies won't make as much money as quickly! Yeah - right - we want to go right back to the housing bubble!

NOT!

Audrey

 

[Gone4Good]

I believe "normal" as defined in the post-WW2 economic boom was an unsustainable anomaly. I think it might be wise to assume slower real growth in the decades ahead given all the headwinds faced by the economy -- globalization pressuring wage growth, huge debts, massive underfunded public liabities, fiat money with the printing presses cranked up and the obvious need for higher taxes to climb out of the hole will all exert pressure. And while some of them may be surmountable by themselves, together I don't see how we can pretend it's 1955 any more.

Sounds a lot like Bill Gross' "new normal". It's hard to argue with. The one thing that gets you out of that box is explosive productivity . . . so far so good on that front.

 

[Independent]

Lots of good posts here. I'll just summarize my thoughts, which appear to be consistent with some other posts.

1. Bank panics are so destructive that it's worth trying to minimize them.

2. Regulation is never perfect, but this is a big enough deal that we should do a reasonable amount of smart regulating.

3. We figured out the principles of bank regulation in the 1930's - Capital requirements, insurance, discount window, gov't sponsored euthanasia. These things worked pretty well for traditional commercial banks.

4. Over the years, the banking system evovled, regulation should have evolved with it.

5. Instead, we got people in charge who believe that all regulation is always bad. They didn't change the regs to keep up with the changing system. They even reversed some good regs.

6. So we had a bigger crises than we should have.

Going forward, we need to apply the old regulatory principles to the new system.

Mankiw had a link to a nice study that said the old style bank panic was depositors physically walking into banks and closing checking a savings accounts. This crisis had big financial institutions (e.g. Fidelity) electronically failing to renew overnight repo agreements. Same old idea, but new wrapper.

 

[Gone4Good]

I'll just summarize my thoughts, which appear to be consistent with some other posts.

I think you summed it up quite nicely.

What I find interesting though is how little dissent this has garnered. I wonder if that reflects a true consensus. Or is it simply because the loyal opposition hasn't revved up the talking point machine yet.

 

[ziggy29]

What I find interesting though is how little dissent this has garnered. I wonder if that reflects a true consensus. Or is it simply because the loyal opposition hasn't revved up the talking point machine yet.

Sometimes we all know we need to get from Point A to Point B.

But that point, the "dissent" usually involves disagreement about which route to take in order to get there.

 

[audreyh1]

It looks like Lehman committed outright fraud. This would already be covered under Sarbanes Oxley and can be prosecuted. Right now the SEC is looking into who else pulled this same "accounting trick".

In March of 2008, several months before the "collapse", the SEC was warned that Lehman's numbers couldn't be right. FT.com / Companies / Banks - Rival warned regulators over Lehman

If you put top people in the SEC who are willing to enforce the law, a lot of these shenanigans will be curtailed. If you put top people in the SEC who feel that "hands off" is the best approach and ignore warnings - well, then, no one is minding the store.

We still need to put in some sensible controls. But the above issue (effective enforcement of existing laws) also needs to be addressed.

Audrey

 

[ziggy29]

We still need to put in some sensible controls. But the above issue (effective enforcement of existing laws) also needs to be addressed.

Agreed. New laws won't help if we can't even adequately enforce existing laws.

 

[audreyh1]

Agreed. New laws won't help if we can't even adequately enforce existing laws.

Well, we still need new laws to (re-)segregate different (conflicting) kinds of financial activity IMO, but we also need to enforce existing ones.

Audrey

 

[Westernskies]

I think you summed it up quite nicely.

What I find interesting though is how little dissent this has garnered. I wonder if that reflects a true consensus. Or is it simply because the loyal opposition hasn't revved up the talking point machine yet.

Agree, this was a good summary. I won't speculate on whether this represents a consensus. Maybe the "loyal opposition" (as you so nicely categorize) realizes the futility of trying to discuss meaningful solutions in the current political environment. Better to just let 'em keep digging...

 

[Westernskies]

Agreed. New laws won't help if we can't even adequately enforce existing laws.

Ziggy, you sound like the NRA talking about gun control.

 

[IndependentlyPoor]

The devil himself is getting frostbite, hell is freezing over.

Did the Texas legislature actually get something right? This article in Slate (of all places) via The Big Picture.

The Lone Star Secret | The Big Money

The article claims that Texas' restrictions on cash-out refinancing were an important factor in avoiding the real-estate debacles of California, Florida, and others. Actually, Texas has only allowed home-improvement loans since 1998 (and I was impressed that the article pointed this out).

So what do you folks think? Is this a reasonable regulation for the federal government to impose?

 

[REWahoo]

Interesting article. I really wasn't aware that once the Realtor's lobby finally lost the fight to legalize home equity loans, TX mortgage laws differed that much from the rest of the US.

IP, I wouldn't jump to any rash conclusion and give the legislature credit. I think this is nothing more than one of the rare instances when the law unintended consequences produced a positive result.

 

[audreyh1]

TX has such a real-estate fiasco in the 80s that it's real-estate lending laws became very, very conservative. And as such we avoided most of the problems of the recent real-estate bubble.

Audrey

 

[Gone4Good]

If you put top people in the SEC who are willing to enforce the law, a lot of these shenanigans will be curtailed. If you put top people in the SEC who feel that "hands off" is the best approach and ignore warnings - well, then, no one is minding the store.

This looks to be one of the shortcomings of the Senate regulation. It sounds like they are laying out some broad guidelines and leaving a lot of leeway for regulators to interpret the rules. This probably makes sense in some cases, but certainly runs the risk that we'll see looser and looser rules as time goes by.

One area in particular that could use some explicit language is for capital requirements. The House bill set a maximum leverage at 15:1, whereas the Senate bill leaves that to be determined by regulators. I'd like to see our financial reform be as idiot proof as possible so that it will still work when we get the inevitable idiot regulator in charge. 15:1 sounds pretty idiot proof to me.

 

[Gone4Good]

And so it begins. It appears the public campaign against financial reform will use both revisionist history and ridiculous assumptions . . .

The Dodd Bill: Bailouts Forever

The cliff notes version of the article is that we don't need the "Dodd Bill", or any other bill apparently, because bankruptcy for large financial institutions works just fine.

In the "revisionist history" camp falls the notion that Lehman's bankruptcy was anything but a disaster for the financial system and the economy. That a bankruptcy court is capable of dealing with the estate is little consolation when bankruptcy perpetuates the cascading failure of financial firms.

In the "ridiculous assumption" camp is the notion that some future administration will act differently than the prior one when confronted with an imminent financial collapse. If anti-interventionist President G. W. Bush and Treasury Secretary Hank Paulson came 180 degrees on the question of financial bailouts, who can reasonably expect some future president to come to a different conclusion when faced with the same circumstances?

The precedent is set. The future is clear. Large financial institutions will be bailed out if the stability of the financial system is at stake. That is true regardless of what happens, or doesn't happen, in the legislature. Making strong declarations, under sunny skies, that "From this day forward, we will not bail out any financial firm" rings hollow and will surely prove untrue when storm clouds gather again. What we need now are not false declarations but strong rules to prevent the kind of reckless behavior that makes bailouts necessary.

 

[Westernskies]

And so it begins. It appears the public campaign against financial reform will use both revisionist history and ridiculous assumptions . . .

...and this thread has now come full circle. Obviously, Congress knows what is best, no need for public input or dissent.

 

[Gone4Good]

...and this thread has now come full circle. Obviously, Congress knows what is best, no need for public input or dissent.

I thought I was providing both public input and dissent.

Or is it only dissent against the government that counts?

I'll just add that Peter Wallison, from the American Enterprise Institute, isn't arguing against a specific reform in as much as he is arguing against reform at all. And that seems to be where we're heading in this debate. A full frontal assault against doing anything. It actually sounds familiar.