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Monday, April 05, 2010

Paul Krugman: Making Financial Reform Fool-Resistant

Is financial reform legislation currently on the table sufficient to fill the "gaping hole" in regulatory oversight?:

Making Financial Reform Fool-Resistant, by Paul Krugman, Commentary, NY Times: The White House is confident that a financial regulatory reform bill will soon pass the Senate. I’m not so sure, given the opposition of Republican leaders... But in any case, how good is the legislation on the table, the bill put together by Senator Chris Dodd...?
Not good enough. ... Now, it’s impossible to devise a truly foolproof regulatory regime — anyone who believes otherwise is underestimating the power of foolishness. But you can try to create a system that’s relatively fool-resistant. Unfortunately, the Dodd bill doesn’t do that.
As I argued in my last column,... the core problem with our financial system ... is ... that the current system doesn’t limit risky behavior by “shadow banks,” institutions — like Lehman Brothers — that ... are perfectly capable of creating a banking crisis, but ... face minimal oversight.
The Dodd bill tries to fill this gaping hole in the system by letting federal regulators impose “strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity.” It also gives regulators the power to seize troubled financial firms — and it requires that large, complex firms submit “funeral plans” that make it relatively easy to shut them down.
That’s all good. ... But ... everything is left at the discretion of the Financial Stability Oversight Council, a ... task force including the chairman of the Federal Reserve, the Treasury secretary, the comptroller of the currency and the heads of five other federal agencies.
Mike Konczal of the Roosevelt Institute ... has pointed out what’s wrong with this: just consider who would have been on that council in 2005,... probably the peak year for irresponsible lending.
Well, in 2005 the chairman of the Fed was Alan Greenspan, who dismissed warnings about the housing bubble... Meanwhile, the secretary of the Treasury was John Snow... Karl Rove treated him like an errand boy.
The comptroller of the currency was John Dugan, who still holds the office. He was recently the subject of a profile in The Times, which noted ... he ... almost never acts to protect consumers.
Oh, and on ... consumer protection: the Dodd bill creates a more or less independent agency to protect consumers... That’s a good thing. But it gives the oversight council the ability to override the agency’s recommendations.
The point is that the Dodd bill would give an administration determined to rein in runaway finance the tools it needs... But it wouldn’t do much to stiffen the spine of a less determined administration. On the contrary, it would make it easy for future regulators to look the other way as another bubble inflated.
So what the legislation needs are explicit rules, rules that would force action even by regulators who don’t especially want to do their jobs. There should, for example, be a preset maximum level of allowable leverage — the ... House sets this at 15 to 1, and the Senate should follow suit. There should be hard rules determining when regulators have to seize a troubled financial firm. There should be no-exception rules requiring that complex financial derivatives be traded transparently. And so on.
I know that getting such things into the bill would be hard politically: as financial reform legislation moves to the floor of the Senate, there will be pressure to make it weaker ... in the hope of attracting Republican votes. But I would urge Senate leaders and the Obama administration not to settle for a weak bill, just so that they can claim to have passed financial reform. We need reform with a fighting chance of actually working.

    Posted by on Monday, April 5, 2010 at 01:26 AM in Economics, Financial System, Regulation | Permalink  Comments (45)


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