Regulatory Reform For Finance: Three Views

There are three views on who exactly is behind financial regulatory reform package that will be officially presented Wednesday lunchtime (update: NYT.com has the draft).  Each view has distinct implications for political dynamics going forward.

The first view is that Tim Geithner and Larry Summers have genuinely become radical reformers.  They see the error of the ways they pursued during the 1990s – both in terms of financial deregulation for the United States and in their advice to other countries, particularly through the capital market liberalization policies urged upon the IMF.  They now seek to put globalized finance back in its box and will pursue any sensible means possible to this end.

This view is not widely held.

The second view is the consensus: Geithner and Summers want a minimal degree of reform with a great deal of window dressing.  This interpretation is supported by the fact that most of the specifics with regard to large financial firms look like moderate technocratic tweaks, i.e., hardly what you’d expect in the aftermath of what the President himself called, “the worst financial crisis since the Great Depression”.

It’s true – and always pleasing to officials – that you can get a nice media bump with background briefings on all the effort that has gone into the proposals.  But honestly, what in the administration’s proposals is strong enough to have prevented this crisis, let alone preempt the next crisis which, by all indications, could be even larger – now that big financial players know for sure they are too big to fail?

The administration could have taken over Citigroup – e.g., placing it into negotiated conservatorship – at several points in the last nine months.  It did not.  Draw your own conclusions and think for a moment about how this will influence future actions in the financial sector.

The third view is more interesting and also controversial: Geithner-Summers have exercised an effective veto over measures that would have constrained large firms directly, but they are not at this time strong enough to prevent sensible consumer protection measures from also going forward.

In this view, someone (Cass Sunstein?) and his/her allies have managed – at least so far – to promote the idea of a consumer protection agency focused on financial products.  The details are not yet clear enough to see how what will emerge, and we also don’t yet know how vigorously Treasury will defend this idea against the financial sector lobbies.  But at least this is something new and potentially powerful in all the right ways.

Sunstein, of course, is known for the idea of a Nudge – pushing consumers ever so gently towards better decisions.  It’s a fine principle to guide thinking, but lobbies, opponents within the administration, and members of congress with their own agenda will not be moved through gentle means. 

This is going to be quite a fight.

By Simon Johnson

32 responses to “Regulatory Reform For Finance: Three Views

  1. Pingback: Your Breakfast Read: Anywhere but Jersey « The Confluence

  2. Draw your own conclusions and think for a moment about how this will influence future actions in the financial sector.

    Future “actions” in the financial sector will be nowhere near as wreckless as what we just witnessed, at least for the next several years. The pall over the sector is so thick, and the ongoing writeoffs so relentless, that it will be at least three years before managers at these firms even think about coming out of their bunkers, let alone dreaming up new ways to game the system. The system is still impaired so badly that the risks are still TODAY’S risks, not tomorrow’s.

  3. Who is to big to fail. Our largest institution is government. Governments sometimes fail. Prudence, indeed, will dictate that Governments long established should not be changed for light and transient causes; and accordingly all experience hath shewn that mankind are more disposed to suffer, while evils are sufferable than to right themselves by abolishing the forms to which they are accustomed.

    But now we have other large institutions. Citigroup is or was bigger than many governments. The competitive model – that we should let enterprises fail when the err – that protection against failure sets a precedent – this model has its merits. But maybe the Prudence argument has merit for large institutions that are not governments. There is a cost to failure, and reform may be a better option for our society, moral hazzards aside. Moral hazzards are quite immeasurable, rather speculative, anyway, are they not?

  4. This is going to be quite a fight (& has been) between the greedy & stupid and the economy. Hopefully the economy will win, but it will take quite a bit more time & pain.

  5. A financial consumer protection agency could be a clever way to counteract financial sector lobbies. It may also provide a venue for international financial cooperation.

    But could such an agency be powerful enough to give the consumer a voice at shareholder meetings, influence executive pay, and enforce transparency of financial products?

    If the administration takes the consumer protection path to deal with the financial crisis, it first has to “stress test” the agency itself.

    Victoria

  6. Pingback: What To Think About Obama's Regulatory Reforms? - The Plank

  7. Pingback: Economists React: For New Financial Regulations, Devil’s in the Details - Economix Blog - NYTimes.com

  8. There will be no fight. Who would be fighting?
    One flavor of political appointees against another?

    It is Congress’ job to fill the antagonistic role of legislative against executive. Data point war supplemental: the “loyal majority” (formerly known as the “loyal opposition”) is now “supporting the president”.

    The rump opposition? Bought and paid for, inconsequential, and fighting for corporate interests anyway.

    That leaves “The People” – those whose 401(k)’s and pensions took a 2.5 trillion 40% hit last year, and whose future is being bargained away to make whole bondholder elites foreign and domestic. I see the stimulus, I do not quite see a response. Something wrong with that patella.

    There is no fight over the lipstick color to be placed on the pig. That is not even kabuki, just method acting.

  9. Pingback: Wednesday links: random market moves Abnormal Returns

  10. We are indeed hearing more and more about the consumer protection side of this. Unfortunately, consumer protection really isn’t the fundamental problem.

    Let’s say a banker lent $700,000 of his own money to a person who was making $20,000 a year, and the $700,000 didn’t get paid back. We are supposed to fix this by “protecting” the consumer from taking the money? Why bother? This only becomes a problem when the banker is lending the $700,000 from a source that the government has determined is systemically important enough to be regulated. It is fundamentally a problem of creating a workable regulatory system.

    Of course, if the administration had wanted to do something meaningful on the consumer side it would not have rolled over on bankruptcy reform. So it is probably a mistake to take any part of this proposal seriously.

  11. Lavrenti Beria

    “But honestly, what in the administration’s proposals is strong enough to have prevented this crisis, let alone preempt the next crisis which, by all indications, could be even larger – now that big financial players know for sure they are too big to fail?”

    Why three ways of looking at what amounts to the corrupt judge giving himself a pardon when this one at least approaches the truth? Dean Baker is considerably less confused about the matter:

    http://www.prospect.org/csnc/blogs/beat_the_press

    Although their protests seem to have been mostly inspired by a bought-and-paid for Western media that can’t imagine the election to office of anyone but the well-to-do and the well-educated, at least the mobs in Iran over the last few days can act on a perception of being criminally abused. Not so here.

  12. Marie Antoinette

    I would like to think that Elizabeth Warren is the power behind the consumer protection arm of this proposal than anyone else. She has been the loudest voice on our behalf.

    That said, it is true that this is the wrong end of the equation to start from if you actually want to fix any problem. I am not an infant who needs to be protected from legally available options. I need the options to reflect an honest, sustainable marketplace. I don’t want someone to hold my hand as I pick a credit card or a mortgage. I want to know that the available choices won’t lead me to bankruptcy and the economic system to collapse.

    Isn’t there a difference?

  13. Pingback: They’ll Be Watching the Defectives - The Opinionator Blog - NYTimes.com

  14. Marie Antoinette: “That said, it is true that this is the wrong end of the equation to start from if you actually want to fix any problem. I am not an infant who needs to be protected from legally available options. I need the options to reflect an honest, sustainable marketplace. I don’t want someone to hold my hand as I pick a credit card or a mortgage. I want to know that the available choices won’t lead me to bankruptcy and the economic system to collapse.

    Isn’t there a difference?”

    I agree with your perspective. However, the difference does not matter all that much.

    As anne has pointed out (if I understand her correctly), we did not get here without a lot of fraud. Illegality is not a necessary part of bubbles and busts, but they attract it. From borrowers who lied about their income to lenders and brokers who assured people that they could refinance when their payments went up. If everybody who broke the law in this bad business went to trial, the courts would be clogged for years.

    I do not know how this financial protection agency would work, but if it outlawed mortgage contracts that required a lawyer to understand, that would be a big boon right there. If it mandated standard practices for ordinary consumers, that would be a boon. It could do a lot to assure that a lot of bad business would not be done. Or it could be window dressing.

  15. Wow, I still have seen no reference to the masterfully researched, prepared and presented report of the COP (Elizabeth Warren’s group) which was issued in January. It’s forthrightness, intelligence and cogency are very special, and seem to be somewhat ignored in this process (although it is where the CFPA idea seemed to originate). I hope that as this proceeds through Congress that her report will be given open and respectful treatment. This will be the first really major legislative test of the current power of the financial lobby.

  16. The UK is showing signs of looking into this issue of being too large too fail. Bank of England Governor Mervyn King apparently made the following comment, “If some banks are thought to be too big to fail, then, in the words of a distinguished American economist, they are too big.”

    http://uk.news.yahoo.com/22/20090617/tpl-uk-britain-king-banks-20b2d2f.html

  17. Read the outline set forth in the COP January report on a solution to regulation. It addressed most of those issues, in the ways that you suggest. (see Congressional Oversight Panel website for a copy, it’s good reading)

  18. They still don’t get it. Writing more meaningless crap regulations is a waste of their, our & mostly the economy’s time. Giving people more authority & responsibility over the financial sector without holding them accountable is an exercise in futility.

    Bernanke, Geithner & their thousands of subordinates were given authority & responsibility (and paid fat salaries) to prevent a crash of the financial system & they failed miserably. And Obama still hasn’t held them accountable. If fact he’s added insult to our intelligence by giving these same inept failures authority over fixing the crash they had the authority & responsibility to prevent.

    I think accountability is a meaningless concept for Obama. Look at his association with the illustrious Rev. Wright. Does anyone think that Bernanke & Geithner would have given trillions of our dollars to the stupid bankers if they knew they were going to be held accountable for the results?

    Either these people are too stupid to see this or they are knowingly doing extreme damage to the long term viability of the country they happen to live in. Like Congress. I’m voting on stupidity.

  19. I used to do real estate transactions, and had to spend literally hours helping my customers understand the minutia of the mortgage process and documentation. And most of them were college graduates!! I could see then that the way these massive documents were structured could only be understood by attorneys. Half of the loan officers I dealt with didn’t even understand everything about what they were selling!! That is really scary. I believe that it was William Shakespeare who said “kill all the attorneys.” I wouldn’t go that far, but I would say that the transparency issue is perhaps the most important one of all. Attorneys are paid to help firms make money. Part of their responsibility is to effective mask risks and emphasize rewards. They do this very well. It’s not illegal, but I believe that is is truly unethical. That said, I also know that we cannot ever truly legislate morality, and it is dangerous to do so.

  20. You obviously haven’t done much reading about the crisis, but I do agree with what you say about B, G, and S. However, that having been said, we definitely need to get a freshly invigorated regulatory environment going. The old one has too many problems: specifically, too many holes, and not enough regulatory attention. I am especially happy to see that the CRA’s will be appropriately controlled, since what they did in rating deritivates was perhaps the largest contibutor to the crash.

  21. OOPS: derivatives is what I meant.

  22. Seeking Safety

    Does the recent announced regulatory reform by Obama mean that the emerging markets can now put up a straight face to the US and simply say that we do not regard your financial system safe and therefore no US i-banks can participate in their markets? What is in the mind of Goldman Sach’s knowing that the largest part of their future growth may come from these markets?

  23. “I am especially happy to see that the CRA’s will be appropriately controlled—”

    Looks like you missed my point. There were plenty of regulations on the books to have prevented the crash. But, they weren’t enforced because the enforcers knew they would not be held accountable. A regulation on paper doesn’t buy you anything. It is no guarantee of compliance. Accountability for enforcement does. How do you hold them accountable? You fire them as a start.

    Geithner even argued for reduced capital requirements at banks while Chairman of the NY Fed.

    From Wikipedia -

    “In May 2007 he worked to reduce the capital required to run a bank.”

  24. You ask for too much. This is congress we are talking about who gives the up or down vote.

    Congress: The land of the compromised.

  25. It’s hard for me to criticize President Obama, because politically it’s hard to say if he could get more done than this. Many things a President may want to do, are very difficult to enact because of politics and the banking lobbies. One of the better outlines of the things which should have been included in the reform package was given by Robert Reich on his website. It’s not perfect, but with just 3 major points Reich does an excellent little essay. The only thing I can think at the moment to add to Reich’s wish list on finance reform would be to MAKE ALL CREDIT DEFAULT SWAPS ILLEGAL.
    Obviously Obama’s reform package as revealed today falls WAY short on many of Reich’s essentials. It’s extremely extremely disappointing. I don’t blame Obama for this extreme disappointment. I just feel sad our system has presented Obama with this sad political reality. The political reality that what bank executives and bank lobbies say is considered more important than depositors and families suffering foreclosure. Here is the link to Reich’s essentials of market reform.

    http://robertreich.blogspot.com/2009/06/three-essentials-of-financial-reform.html

  26. Pingback: The Defanging of Obama’s Regulation Plan - Economix Blog - NYTimes.com

  27. Pingback: When Market Incentives Lead to Bad Outcomes, Continued « The Baseline Scenario

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  30. michael donner

    Obama gave the best, most pitch-perfect speech about financial reform at Cooper-Union NYC during his campaign. Obama spoke eloquently and with ease about the need to reinstate a new 21st century Glass-Stegall and how Wall Street was not the friend of Main Street, how Mom and Pop must be protected from powerful unregulated hedge funds and the vicious short-selling traders who only profit through speculation and manipulation. It sounded so good.

    On stage with Obama that day was an impressive cast of economic talent/clout. Highly respected anti-neolibs like Volcker and I think Stiglitz were present but then paradoxically, so was the free-market/neo-liberal crowd like Larry Summers and Robert Rubin, the very man who was almost solely responsible for killing Glass-Stegall in the first place. ( I think we all know the rest of the story) So I wondered which economists on stage that day were the real Obama economists and which ones were the campaign props? (parts stolen)

    those were simple, clear ideas that we already voted for. what happened i wonder?

  31. michael donner

    great post by Karl Denninger at market ticker http://market-ticker.denninger.net/

    the best take-a-way for me was how completely Obama missed the root of the problem..not getting lending going again and reinflate (some of the ‘reasons’ for his plan)…rather TOO MUCH DEBT already and tapped out borrowers, student loans, credit cards, auto payments, home mortgages, lost jobs….so regulating the FIRE so they can continue lending and scamming us back to 2005 is clearly not the answer.

  32. I’m not usually one to defend Summers and Geithner but saying that they “want a minimal degree of reform with a great deal of window dressing”…sounds a bit harsh. To me it feels as though no one wants to go WAY overboard (which would be predictable in a situation like this) but the administration recognizes change is needed…