Saturday, April 17, 2010

Financial Reform?

Financial reform appears to be next on the Obama agenda. This is going to be present a tough political issue for a movement dedicated to smaller government that remains within its constitutional bounds. The bank bailouts, followed by reports of fat bonuses for top banking executives makes them a ripe target for retributive justice through by means of increased regulation. However, the nature of the reform matter deeply. First, we have to ask ourselves if the current regulatory regime is actually inadequate. Initially, it appears obvious that the current system failed. But while that is true, it doesn't mean that the current laws failed in their entirety. The Senate banking committee has conducted a yearlong investigation into the failure of Washington Mutual. I don't always believe everything I read from the Senate, this has some interesting facts:

A year-long Senate probe presented at a hearing Friday concluded that the OTS had identified a pattern of errors, poor risk management and even fraud at Washington Mutual. Yet it took no action to stop the bank from dumping toxic mortgages into the financial system because the bank was a huge moneymaker that paid fees amounting to 15 percent of the agency's budget, the panel said.
Yet OTS examiners refused to lower Washington Mutual's asset quality ratings even though its practices were unsatisfactory because "WAMU was making money and loans were performing," Thorson said. This assessment runs counter to OTS guidelines, which state that demonstrating profitability is not sufficient if an institution has a high exposure to risk, Thorson said.

In this case, there was an office with a specific responsibility to regulate the quality of the banks' loans, but failed. But why do we need such oversight? Because WaMu could package the loans and sell them as securities, while continuing to rake in fees on servicing the loans. Fannie and Freddie played a big role here in enabling this behavior by securitizing mortgages. They did not see their role as anything other than increasing the number of mortgages. Look what happens when that goal was challenged:

Enter bailout nation, in which the government has apparently pledge unlimited funds to bailout not just the dud loans of the nation's banks but apparently the banks themselves as well as their parent corporations.

So what is happening with the legislation? The biggest issue is that "too big to fail" is alive and well, as one might expect in legislation built under Chris "Countrywide" Dodd's tutelage. From the Wall Street Journal:

The Dodd bill, instead, still gives regulators the authority to rescue essentially the entire financial industry. While much debate has centered around the FDIC's new "resolution" authority for failing firms, there's been almost no discussion around a separate FDIC program under which the agency can guarantee corporate debts. To Mr. Dodd's credit, this provision has improved slightly. In an earlier draft, the Fed and the new systemic risk council could have applied FDIC debt guarantees even if the FDIC itself opposed such bailouts.

Now the FDIC has to be on board, but the core problem remains—an even more explicit taxpayer backstop than anything Fannie Mae and Freddie Mac enjoyed during the housing bubble, and one that's available to a virtually unlimited number of firms. Federal regulators can create a "widely available program" to guarantee the debts of not just banks, but their parent companies as well, and all of their affiliates.

Fannie and Freddie were rolling the dice with an implied backstop, but this legislation would allow regulators, without a vote of Congress, to explicitly put the full faith and credit of the U.S. government behind Goldman Sachs, JP Morgan and Morgan Stanley, among others. This list could have more than 8,000 names on it, because any bank or company that owns a bank, or is a affiliated with a company that owns a bank, is eligible.

Sorry this post got so long, but I wanted to air out a big part of the problem. Big Government's regulation and unaccountable bailout are at the root of the financial crisis. I remind the constitutional professor that occupies the oval office of Article 1, Section 9 of the United States Constitution:

No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law; and a regular Statement and Account of the Receipts and Expenditures of all public Money shall be published from time to time.
Time to oppose this legislation with some simple arguments:



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