As a finance person, I assume some may wonder what I think of the financial regulation bill meandering through Congress. As it is a lazy holiday weekend, I’ll outsource it:
In two weeks, I am supposed to speak on a panel entitled “Financial Re-regulation.” My question is, what re-regulation? To me, re-regulation means you would reverse some step that you took toward deregulation. But the new financial reform bill does not reverse any of those steps, as far as I know.
For example, the new bill does not repeal Gramm-Leach-Bliley, a 1989 law that ratified the de facto breakdown of the separation between commercial banking and investment banking, which is often blamed for the crisis. You would think that for symbolic reasons, if nothing else, you would repeal that law and go back to Glass-Steagall. Of course, I do not think there is much connection between GLB and the crisis, so I am not advocating repeal. I am just pointing out an inconsistency between one narrative of the financial crisis (it was caused by GLB) and the actual response.
In fact, if you wanted to restore the distinction between commercial banking and investment banking, you would need an entirely new law. That is because Glass-Steagall did not contemplate money market funds (are they commercial banking or investment banking?) or mortgage-backed securities (same question) or credit default swaps (ditto). There is no clear-cut inherent distinction between commercial banking and investment banking. It is true that some folks have a reasonable intuition that combining certain functions may be anti-competitive or unsafe and unsound, but that intuition needs to be articulated in a way that speaks to the modern financial world.
Back to the main point–if we are re-regulating, then what was deregulated? For example, where did subprime mortgages come from? Can anyone point to a particular legal or regulatory barrier that was removed in the last two decades? If so, has the new legislation restored this barrier?
When banks created structured investment vehicles (SIVs), collateralized debt obligations (CDO’s), and other innovations, did this require a specific deregulation? Were the actions of the credit rating agencies a result of their becoming deregulated in some way? In my own analysis of the crisis, I point to capital regulations that rewarded CDO’s, SIVs, and the manufacturing of AAA-rated securities. But that was not deregulation. And it was not reversed by the legislation.
Perhaps the centerpiece of the new legislation is a consumer protection agency for financial products. But if the core problem was a lack of consumer protection, what we should have seen was banks extracting profits from loans and foreclosures. Instead, banks got wiped out by losses. As Tyler Cowen points out, given where the losses took place we should be talking about predatory borrowing.
As I have said before, there is no coherent narrative that connects an analysis of the causes of the crisis to the financial reform legislation as written. Rather, the bill serves to deflect blame from government’s role in pursuing housing policy through dubious mortgage market intervention and from the mutual overconfidence of large financial institutions and their regulators.
The new law is not re-regulation. The regulations it contains are largely irrelevant to financial stability. And potential regulations that would improve financial stability (such as increasing the use of subordinated debt to discipline banks or requiring sizable down payments on mortgages) are not in the bill.
To sum up: The bill is largely an effort by politicians to say they “did something” without really doing anything.