Democrats say their financial regulation plan will vastly reduce the odds of a future crisis and ensure that taxpayers won’t ever again have to pay for banks’ sins. Skeptics worry — and with good reason — that the White House and Congress are being a little too confident.
Financial crises are complex beasts. Even after they’re over, people have trouble agreeing on exactly what caused them.
So US President Barack Obama’s administration and Congress were smart to avoid the magic bullet trap: The wishful idea that one sweeping solution, like breaking up the banks or proclaiming that the government will never again rescue a collapsing bank, could prevent the next crisis. Their goal instead has been to improve finanuture of interest rates or a pool of subprime mortgages.
Their economic value is that they allow companies to hedge risk. If soaring fuel prices have the potential to bankrupt an airline, it can buy a derivative that pays off if prices jump. Southwest Airlines did exactly this a few years ago.
Unfortunately, many derivatives were bought largely with debt in recent years. When their value fell, owners had little margin for error. The fact that most deals were done privately — rather than through a clearinghouse, with prices everyone can see — made the situation worse by creating uncertainty.
The House of Representatives’ bill would force some trades into a clearinghouse but allows far too many exemptions. The Senate bill is stronger. It’s probably too strong, in fact. It effectively bans many big firms from trading derivatives. That’s not so different from a ban on subprime mortgages, which, of course, also helped cause the crisis. Both derivatives and subprime mortgages can play a useful role. They just need to be closely watched.
The Senate rule, however, does have a silver lining. Wall Street lobbyists have devoted so much energy to fighting the ban that they have not had as much time to fight other (better) parts of the bill they also dislike — like the Senate’s clearinghouse.
Why didn’t any government agency prevent banks from issuing mortgages that homebuyers obviously could not repay?
There were two main reasons: The responsibility for doing so was spread across a handful of agencies, and the most important of those agencies, the Federal Reserve, has never been good at protecting consumers.
So both the House and Senate would create a new consumer watchdog for credit cards, mortgages and other financial products. In the House version, the watchdog is a separate agency. In the Senate version, it is housed inside the Fed — which is less than ideal, given the Fed’s history of deferring to banks. But it’s not a disaster, because the Senate was careful to create an independent budget for the group and let the White House appoint its director.
As Elizabeth Warren, the law professor who developed the watchdog idea, said: “The consumer agency in the Senate bill is strong, but there is no margin for error.”
You can expect lenders, ranging from big banks to car dealers, to try to weaken the agency during House-Senate talks.
The Fed has still accepted almost no responsibility for its mistakes during the housing bubble.
“Like other regulators, there were some things we could have done, at least with hindsight,” Fed Chairman Ben Bernanke recently said. “But we had neither the mandate nor the tools to be the financial system’s supercop.”