After months of internal debate, President Obama today released his much-anticipated plan for reforming the nation’s financial regulatory system. The 85-page document is nothing if not comprehensive, containing a grab bag of changes covering almost every aspect of the troubled financial industry. Taken as a whole, the changes would trigger the largest increase in government intervention in the sector since the Great Depression, to the detriment of consumers. What’s worse, the proposed changes are unlikely to resolve the real problems facing the industry.
Among the key provisions of the plan:
* Systemic Regulation. The Fed, as advised by a newly-created “Council of Regulators,” would be charged with regulating “systemic risks” to the financial system. Yet, while the Fed’s power would be extensive — reaching even to private equity and venture capital firms — it is difficult or impossible to define or identify systemic risks before they appear (as argued by David John here).
* Consumer Regulator. A new “Consumer Financial Protection Agency” would be created to regulate mortgage lending, credit cards, and other forms of consumer finance. But while fraud and deception should be severely punished, few argue that fraud and deception had much to do with the current crisis. Worse, the proposed new agency is likely to limit consumer choice — by banning disfavored products — rather than increase it. In any case, existing agencies, such as the Federal Trade Commission, should be charged with this issue, rather than create a new regulatory bureaucracy.
* Resolution Authority. The FDIC would be granted the power to close and wind down the affairs of non-bank financial firms (upon approval of the Treasury Department). Currently, the FDIC only has such power over banks which it directly insures. This authority, however, would provide enormous — and potentially dangerous — power to the FDIC, providing it immense discretion over how institutions are reorganized, and the disposition of their assets. The recent government-controlled bankruptcy proceeding of Chrysler should give warning as to how this power could be recognized. Moreover, as outlined earlier this year by the Obama Administration, it would institutionalize the granting of bailouts to failing institutions.
Far better to use the long-established bankruptcy process — with its legal rules and protections — in closing down financial institutions. If necessary, minor changes could be made to the current bankruptcy code so as to ensure that firms are wound down in an orderly manner, while preserving the process and rule of law essential to a fair, and non-political, resolution. (One proposal for such a system was recently floated by House Republicans.
Of course, there are some positive aspects to the Obama plan. He recommends eliminating remaining limits on interstate banking. And, certainly, there are real problems in the current system that need to be addressed. But the plan offered today puts far too much faith in regulators to guide markets to where they should be. That is consistent neither with economics nor, given the role of many federal policymakers in contributing to the current crisis, with recent history. A better plan — one that empowers consumers, rather than regulators — is needed.
