The plan is built around five key points, according to a briefing last night by senior administration officials and a copy of the white paper obtained by The Washington Post.
The proposals would greatly increase the power of the Federal Reserve, creating stronger and more consistent oversight of the largest financial firms.
It also asks Congress to authorize the government for the first time to dismantle large firms that fall into trouble, avoiding a chaotic collapse that could disrupt the economy.
Federal oversight would be extended to dark corners of the financial markets, imposing new rules on trading in complex derivatives and securities built from mortgage loans.
The government would create a new agency to protect consumers of mortgages, credit cards and other financial products.
My response goes something like this. We live in an imperfect world
with imperfect regulations on financial markets. Hence, there exist
policies that would represent an improvement on the current system, but
there are also many (more) ways to mess it up even worse.
It would be much easier if we could close our eyes, make a wish, and
eliminate stupidity and dishonesty. But since that won't happen, let's
think about whether the Obama plan would represent an improvement.
Hopefully it would put a stop to the "too big to fail" argument. Obama seeks to give the government (Fed) the ability to break up large bank holding companies that get into trouble. But the only part of the white paper where this is directly mentioned (that I can find) is pages 74-76. To say it is short on details would be charitable. Granted, this is something where the rules would probably be written on the fly, but then, isn't that what we're doing now? Is it enough to just say that we'll let the Fed do what it needs to do? If we did write rules for this, could the end up being too constraining? This is a really tough problem, and I don't think they've solved it.
On the plus side, the document does spend a few pages suggesting a larger role for the Fed in overseeing the payments, clearing, and settlement systems. Now that's something that is actually within their proper scope of regulation anyway. That seems like a winner. (But also short on details.)
More rules on trade in derivatives is also something that I would support if done right. I'll need to think more about what is the right way.
But the document also spends a disproportionate amount of pages discussing how to protect consumers from "financial abuse." In fact, in my perusal of the document tonight, I see the most detail in this section. Among other things, they would like to mandate that a traditional fixed-rate 30-year mortgage ("plain vanilla" as they put it) be offered alongside any other lawful mortgage products, and that the consumer be given the tools to compare the various products.
Sorry, I don't see this as making much difference. We already have disclosure requirements that kill quite a few trees for every mortgage closing. With all of the information shoved in front of the homebuyer, most people just shut up and sign. Will giving them more information (as opposed to useful knowledge--which cannot just be given) really make a difference? If you're an unethical mortgage broker, don't you think that there will be a way to game this system to your advantage (offering fixed-rate mortgages at exorbitant interest rates to discourage their use, for example)?
Yet this seems to be where the administration is focusing its efforts.
Fortunately, there was some other insightful comment on regulation today. Arnold Kling writes in a guest column at the Washington Post:
In my view, the worst regulatory error was allowing bank capital regulations to be evaded. In the late 1980s, after many savings and loans had failed in the United States, international bank regulators developed the Basel capital accord. Although this was flawed in many respects, it did represent a formal requirement for banks to hold capital based on risk. Most assets required 8 percent capital. Some low-risk assets required 4 percent capital, and some government securities required even less.
Soon after the capital accords were rolled out, banks began to come up with ways to "game" the system. For mortgages, the two most important techniques were securitizing mortgages and creating off-balance-sheet vehicles. Securitization allowed banks to get large portions of their mortgage portfolios rated AAA, and these AAA ratings in turn lowered capital requirements, particularly after a revision to the capital requirements that was formalized on Jan. 1, 2002. The off-balance-sheet entities were an even bigger scam, because generally-accepted accounting principles (which the regulators copied) allowed the banks not to count the mortgage securities in these entities as assets at all.
All of this was done right under the nose of the regulators. An article in 2000 in the Journal of Banking and Finance,called "Emerging problems with the Basel Capital Accord: Regulatory capital arbitrage and related issues," was written by a Federal Reserve staffer. Although such scholarly articles always carry disclaimers that the contents do not represent the opinions of the Fed, it clearly showed an awareness of how banks were using techniques to evade capital requirements. The author rationalizes this in part by suggesting that without the ability to evade capital requirements, banks would have been less competitive in the market to finance mortgage loans or other low-risk assets.
I think Kling is on the right track. If financial market regulation is like firefighting, then to prevent this sort of gaming of the system would be like starving the fire of fuel. A different tactic than pouring water on the fire, but still effective--sometimes more so.
At Marginal Revolution, Tyler Cowen writes:
The broader point is this. Better regulation comes through many years of experience and gradual process improvements, built upon some reasonable methods for imposing regulatory accountability. That's how the FDIC got to be good at much of what it does. Better regulation does not come from sitting down, waving a wand, and hoping that a new name or box will address the problem you are concerned about. Keep that in mind next time you hear that "now is the unique moment," etc.
Well put. Doubling or tripling the amount of paper shoved in front of a home buyer at closing won't do it either. There should be changes. But there really isn't any need to rush something through by the end of the year. We're not in danger of a repeat of the circumstances that laid the groundwork for the crisis any time soon. So take some time and do it right. There might be a few good ideas in the Obama plan, but there is also a lot more alphabet soup without a lot of details about how it will all work.
Felix Salmon calls it a bust as well.
The only real way to keep our economy strong is not by raising taxes, but by keeping taxes low, fair and simple. I've been looking for a way to take action and contact our legislators and sign petitions and found some good policy the U.S. Chamber of Commerce backs (here). I don't have a lot of money or time, but I figure this will help other people do good.