“My instinct is to call the proposed legislation a "blame deflection bill" rather than financial reform. But I admit that I have not read the whole bill. Has anyone?
My impression is that the following things are not in it.1. No exit strategy from government support for subsidized, lenient mortgage credit. No curbs on Freddie and Fannie, whose market share has skyrocketed in the past year and a half. No increase in down payment requirements for FHA, which is in deep doo-doo.
2. No change to the role of credit rating agencies, as far as I know. It seems to me that one thing that everyone, left and right, can agree on is that the regulators outsourced their function to the credit rating agencies, and this worked out badly. As far as I know, the bill does not correct this flaw. Perhaps it tries to, but other provisions have gotten more attention.
3. Nothing to address the issue of "cognitive capture." The regulators will still get their analysis of the financial sector from the CEO's of the largest banks.
4. Finally--and this will get me in big trouble--I have to rant about the notion of a consumer financial protection agency. I know that it's axiomatic that poor people are helpless victims. But in the case of these mortgages, that is a really hard sell. The banks did not take from poor people. They gave to poor people. If you were lucky enough to get one of these exotic mortgages when house prices were still going up, then you got to reap a nice profit on your house. If you were not so lucky, you lost...close to nothing. I'm sorry, but if you borrowed up to 100 percent of the value of the house or more, then all you really lost were your moving expenses.
What about predatory lending? As I understand it, the idea of predatory lending is to saddle the borrower with an expensive mortgage so that you can foreclose on the property and sell it at a profit. How many times did that happen? Have you read of a single instance in the past three years where the bank made a profit on a foreclosure?
I am always ready to feel sorry for poor people because of their poverty. But I cannot feel sorry for somebody who was given a basically free option on a house and the option didn't happen to come into the money.
The reason that those of us on the right are left somewhat speechless by the financial reform bill is that it seems to us to be based on premises that strike us as preposterous.”
Arnold Kling, “What I think about financial reform”, Econlog Blog (22 April 2010).
http://econlog.econlib.org/archives/2010/04/what_I_think_ab.hmtl
Arnold Kling is a noted economist who has worked for the Federal government for many years in different capacities and as a professor at several universities. He is a founder and co-editor of EconLog, a popular economics blog that reflects Libertarian thinking.
As Dr. Kling implies, the financial reform now being cobbled together in Congress is yet another example of legislation with tremendous ramifications for the country being rammed through the legislative process with little real discussion and no chance for the vast majority of Americans to understand what the bill will do and how it will affect them. The bill is being pushed by Senator Chris Dodd, who in his own way is a genius at crafting legislation that appears to be strong but in the end, despite his words, does little but entrench the powers-that-be in the financial community. He lost a closure vote in the Senate today, but he will be back tomorrow and the next day and the next until some bill is passed.
Comprehensive, sensible reform requires a full discussion of the issues and a step-by-step approach to dealing with the myriad of problems surrounding the reform of the financial sector. It would, at the very least, begin by strengthening the banks and other financial institutions on main street, and then work its way up to the “Big Guys” on Wall Street and the even affect the Megabank conglomerates that spread themselves across the world. It would be concerned with the question of why the financial industry has a strong tendency toward consolidation and merger and how legislation might channel these tendencies in other directions so as to at least mitigate the rise of Megabanks regarded as “too big to fail”. The problem is beyond economics in the sense that these banks have become powerful political actors, too powerful for the political health of the nation. They are also at the very center of the implementation of our monetary policy. It is foolish to think that the regulation and institutional oversight approach to reform pushed by Dodd will constrain them in any significant way.
Moreover, it is foolish to think that the problem of a large and too powerful Wall Street is caused by Wall Street alone. Obviously, the executives of these banks push their contacts with government officials and elected officials in the way that all cronies do, and in doing so gain access to information and influence over policy. But equally, those on the government side regard their contacts with major players in the financial arena as providing them with the information and leverage they need to carry out their responsibilities. In the end, the two sides need each other and in the reform process each side fears loss of what they regard as inside information and influence on the other. For Wall Street enormous profits and great power can be derived from their connections and interactions with the government. What, one might ask, does the government derive from its close cooperation with and support of the Banking Titians of New York?
To understand this, one must go back to the time of Andrew Jackson and his fight with Nicholas Biddle and the Second Bank of the United States. Jackson hated the national debt and did everything he could to rid the country of it. Whether this was wise is the subject of another day. Beyond his dislike of debt was the desire to rid the country of paper money backed by federal bonds and the influence of large, powerful banks over the financial system. Real money to Jackson was specie -- gold and silver coins -- and paper money -- currency, bills of exchange, promissory notes, bank checks, and the like -- was a form of speculation and fraud. But by closing down the Second Bank and not issuing Federal bonds the country lost control of its money supply and a period of extreme financial instability and deep depression ensued. Instead of the stability real money was supposed to bring, the country found an explosion of shady dealings and rampant speculation. In its wake, a wave of bank failures occurred, ninety per cent of the nation’s factories closed and Federal revenues fell by half. Decades of financial turmoil followed as the country gradually learned the importance of a sound monetary framework and the need for close cooperation between the banking system and the monetary authorities. Today, the monetary authorities at the Fed and the Treasury understand full well that their success in maintaining a stable financial environment – not just at home but globally -- depends on their relationship with the “Big Guys” and on knowing what they are up to and influencing their decisions, both formally and informally. Anything that upsets this relationship weakens what they perceive to be a key instrument of their monetary control.
Add to this the problem of financing the Federal deficit. One must understand the Treasury is utterly dependent on the big banks in New York to finance its huge deficits. These banks are the way the Treasury raises money, and weakening them through possibly injudicious reforms threatens the sale of its bonds. The absolutely huge flow of capital required to support the deficit spending of the Federal government necessitates that New York remain the world’s leading banking center so Washington can draw upon the liquidity of the world. If the New York banks go down, the government goes down. It is as simple as that. For this reason the “Big Guys” will always be bailed out. The cronyism, the lax regulation, the unspeakable bonuses, the shoddy handling of mortgages, all these mean nothing against the ever present and ever pressing need to sell Treasuries for a good price at the next auction. And do not think that because the banks have a central position in the drama of government finance that they are all that powerful. They know that if they do not perform their assigned function Washington will come down on them like a ton of bricks. Yes, they are essential to Washington. But in Washington’s eyes, their only role is to sell government bonds and bring in capital from the rest of the world, and anything they do that weakens this role and raises questions about the credibility of the U.S. financial system will be dealt with harshly.
The unholy alliance between Washington and New York will end when the fiscal deficits end. When the Treasury has no great need to sell its bonds and the Federal government no longer depends on foreign sources of finance, then real reform can be undertaken. Reducing the political power of Wall Street is another reason why it is so important to reduce the deficit.
Dr. Kling is right to point out that the proposed legislation contains many gaps and has many weaknesses and fails to focus on what is really important but rather deals with the trivial. I for one am not surprised.
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