The most sensible legislative response to the financial collapse of September 2008 would have been to do nothing until the causes of the collapse were fully understood.
There is no urgency about legislating financial regulatory reform. The existing regulatory agencies have virtually total authority over the financial industry. And because they were asleep at the switch when disaster struck, they are now hyper- alert to prevent a repetition of it. Indeed, bank examiners have become so fearful of condoning risky practices that they are making it difficult for banks to lend to small businesses and consumers and thus are retarding the economic recovery.
The principal factors in the recent economic collapse were:
No. 1. Incompetent monetary policy, which under former Federal Reserve Chairman Alan Greenspan and his successor Ben Bernanke produced the housing bubble that burst, bringing down the financial industry, which was heavily invested in the mortgage market.
No. 2. The inattention of the Fed and the Securities and Exchange Commission, which didn’t understand the changing nature of the banking industry, particularly the rise of so-called nonbank banks dependent on short-term, noninsured capital.
No. 3. The over-indebtedness of the American people and government, which has hampered the restoration of credit.
No. 4. The failure of the Treasury Department under former Secretary Henry Paulson and the Fed under Bernanke to rescue Lehman Brothers Holdings Inc. They didn’t realize that Lehman’s bankruptcy would trigger a run on the banking industry, causing a global credit freeze.
Not Paying Attention
Barack Obama’s main economic officials -- Bernanke, Treasury Secretary Timothy Geithner, and National Economic Council Chairman Lawrence Summers -- were implicated in the regulatory oversights that precipitated the crisis, as were key legislative officials, such as Senator Christopher Dodd and Congressman Barney Frank. None of them wants to shoulder blame for the crisis. Instead, they blame the banking industry.
Banks did take risks that were excessive from an overall social standpoint, but businesses will always take the risks that government permits them to take, especially if the brunt of any harm falls on others.
The costs of the collapse have been borne largely by people and firms that had nothing to do with finance. Some banks took a hit, but the big ones are doing well. The government saved them from bankruptcy and the Fed is allowing them to borrow at interest rates close to zero, thus enabling them to return to profitability without doing much lending and thus without meeting urgent credit needs.
But just as politics requires that President Obama be seen to be doing something about the oil leak in the Gulf of Mexico, though there is nothing he can do, so politics requires that Congress be seen to be doing something to prevent another economic disaster, though there is nothing it needs to do.
The same political imperative led to the reorganization of the intelligence community in the wake of the Sept. 11 terrorist attacks, a move now widely regarded as a failure. Reorganization is a favorite response to a governmental failure because it is visible, easily explainable, and can be done without ruffling too many feathers among interest groups and bureaucrats. It also buys time, since no one expects such reshuffling to be effective immediately.
The new financial overhaul bill is about 2,300 pages long, and though they are pages of large print and broad margins, I defy any single person to claim to have read and understood it all. So far as I can judge, though, much that the bill ordains is within the existing powers of the financial regulatory agencies and is therefore superfluous.
Adding Redundant Layers
The Financial Stability Oversight Council (consisting mainly of the Fed chairman, the Treasury secretary, and the chairmen of the Federal Deposit Insurance Corp. and the SEC) to advise on systemic risk? These officials don’t need legislation to hold regular meetings if that would be useful.
A consumer-protection bureau lodged in the Federal Reserve? The Fed already has such a unit. It is ineffectual because the Fed cares about the solvency of banks, not the solvency of their customers. Congress proposes to cure this skew by making the head of the Fed’s consumer protection staff -- renamed the Consumer Financial Protection Board, since renaming is the least arduous and hence an irresistible form of reorganization -- a presidential appointee, which will create friction with the Fed’s chairman, who might (because he has a fixed term) be a holdover from a previous administration.
Already Helping Consumers
The Federal Trade Commission already has extensive experience in consumer protection and could be given additional resources to police unfair and deceptive practices in mortgage and other consumer lending. If, as some students of finance infer from the extraordinary interest rates that people pay for credit-card debt and other forms of fringe banking, it’s true that Americans simply can’t handle debt responsibly, the only solution is to reinstate usury laws.
The new bill increases the amount of equity capital that banks must hold, relative to their total capital, in order to reduce bankruptcy risk. But the Fed in the case of commercial banks, and the SEC in the case of nonbank banks, already have the authority to decide how much equity capital the firms they regulate must hold.
The legislation requires that most credit-default swaps --a form of credit insurance, but also a device for speculating on bond defaults -- be traded through clearinghouses and on public exchanges, like publicly traded stocks.
Uncertainty about the liabilities and solvency of issuers of credit-default swaps did contribute to the financial panic of 2008, but can be dispelled simply by requiring better disclosure of firms’ off-balance-sheet contingent liabilities. These could include not only credit-default swaps but also the structured investment vehicles in which banks parked their mortgage-backed securities.
It may be argued in defense of the new law’s apparent redundancy that the regulatory agencies didn’t use their authority properly to avert the crisis -- which is true -- so they must be ordered to do better.
But it is a mistake for Congress to tell regulatory agencies in minute detail what to do. The idea behind administrative regulation is that agencies hire experts to deal with technical issues that Congress has neither the competence nor the time to resolve. Legislation once adopted is difficult to change, and can put a regulatory agency in a straitjacket. This is a particularly serious concern in the case of finance, which is undergoing continuous change.
Besides trying to micro-manage the regulatory process in some respects, the new law in other provisions takes a different tack and directs the regulatory agencies merely to study particular problems. This is a waste of ink. All the senior financial regulators are appointees of the Obama administration. If there are areas of financial regulation that would benefit from further study -- and there are -- the administration can tell its appointees to do so. There is no need for a congressional prod.
There are little nuggets here and there, such as the abolition of the ineffectual Office of Thrift Supervision, but on the whole, so far as I can judge, the new law is a political measure in the worst sense.
(Richard A. Posner is a U.S. Court of Appeals judge for the Seventh Circuit and a senior lecturer at the University of Chicago Law School. The opinions expressed are his own.)
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