By Simon Johnson
The political debate about finance in the US is often cast as markets versus regulation, as if “more regulation” means the efficiency of private sector decisions will necessarily be impeded or distorted. But this is the wrong way to think about the real policy choices that – like it or not – are now being made. The question is actually what kind of markets do you want: fair and well-functioning, with widely shared benefits; or deceptive, dangerous, and favoring just a relatively few powerful people?
In a speech on Wednesday, Senator Elizabeth Warren (D., MA) laid out a vision for better financial markets. This is not a left-wing or pro-big government agenda. Senator Warren’s proposals are, first and foremost, pro-market. She wants – and we should all want – financial firms and markets that work for customers, that encourage innovation, and that do not build up massive risks which can threaten the financial system and bring down the economy.
Senator Warren puts forward two main sets of proposals. The first is to more strongly discourage the deception of customers. This is hard to argue against. Some parts of the financial sector are well-run, providing essential services at reasonable prices and with sound ethics throughout. Other parts of finance have drifted, frankly, into deceiving people – on fees, on risks, on terms and conditions – as a primary source of profits. We don’t allow this kind of cheating in the non-financial sector and we shouldn’t allow it in finance either.
The unfortunate and indisputable truth is that our rule-making and law-enforcement agencies completely fell asleep prior to 2008 with regard to protecting borrowers and even depositors against predation. Even worse, since the financial crisis, the Securities and Exchange Commission, the Justice Department, and the Federal Reserve Board of Governors proved hard or near impossible to awake from this slumber.
We need simple, clear rules that ensure transparency and full disclosure in all financial transactions – and we need to enforce those rules. This is what was done with regard to securities markets after the debacle of the early 1930s. The Consumer Financial Protection Bureau (CFPB), for which Senator Warren worked long and hard, has started down a sensible road towards smarter and simpler regulation. The CFPB needs to go further – including on auto loans – and for this it needs renewed political support.
The second proposal is to end the greatest cheat of all – the implicit subsidies received by the largest financial institutions, structured so as to encourage excessive and irresponsible risk-taking. These consequences of these subsidies have already caused massive macroeconomic damage – this is why our crisis in 2008-09 was so severe and the recovery so slow. Yet we have made painfully little progress towards really ending the problems associated with some very large financial firms – and their debts – being viewed by markets and policymakers as being too big to fail.
If you could visit a casino with the prospect of keeping all your winnings, while your losses would be partially or completely paid by someone else, how much would you gamble? You would bet a huge amount – presumably as much as the house allows. Big banks are run by smart, rational people. The incentives they face – which themselves have worked long and hard to retain – are not acceptable from a broader social point of view.
Senator Warren wants to cut through the complex morass of modern regulation. Force the biggest half dozen banks to become smaller, simpler, and more transparent. Limit the tax deductibility of interest for large highly leveraged financial institutions, so they choose to fund themselves with relatively more equity and less debt.
And reform the emergency powers of the Federal Reserve – to strengthen its ability to deal with genuine disasters while also ensuring an appropriate level of democratic review and control. The days of secretive bailouts should end.
Senator Warren’s main point is this:
“without some basic rules and accountability, financial markets don’t work. People get ripped off, risk-taking explodes, and the markets blow up. That’s just an empirical fact – clearly observable in 1929 and again in 2008.”
Of course you cannot outlaw all cheating or prevent all forms of future potential macroeconomic problems. But the legislative framework and presidential priorities matter. This is demonstrated by what happened since the 1980s, when the deregulation of finance distorted incentives in very ways that proved very dangerous.
We can choose now to make markets function better. Put in place simpler, clearer rules and enforce them.
This is a completely centrist agenda. As a result, there is real potential here for bipartisan policy initiatives – and there are senators on both sides of the aisle who show signs of being willing to go to bat for exactly these kinds of sensible pro-market ideas.
All presidential candidates, Republican and Democrat, would be smart to embrace this agenda.