Robert Stolarik for The New York Times The New York Stock Exchange on Friday. Congress is on the verge of adopting the most far-reaching overhaul of financial regulations since the Depression. Though the details of combining the House’s bill with the version passed by the Senate on Thursday still have to be worked out, there is broad support for an expansion of government oversight of the banking system and financial markets.
What will Wall Street look like after the changes are put in place?
- Peter J. Wallison, American Enterprise Institute
- William K. Black, former banking regulator
- Nicole Gelinas, Manhattan Institute
- Rob Johnson, Roosevelt Institute
The Arbiter of Success? The Fed.
Peter J. Wallison is the Arthur F. Burns Fellow in Financial Policy Studies at the American Enterprise Institute. He was general counsel of the Treasury and White House counsel in the Reagan administration.
Leaving aside the particular elements of the bill, its principal thrust is to subject virtually all large and complex nonbank financial institutions — bank holding companies, finance companies, insurers, securities firms and hedge funds — to government oversight and control. The Fed will have the power to set capital, leverage and liquidity levels for all these firms, define their permissible activities and break them up if they are deemed to be a danger to the financial stability.
Competition has been the governing factor in the financial industry. No more.
Along with control, the government will have a number of mechanisms for taking over and winding down the institutions it regulates. Together, these authorities will give the government life and death power over the largest financial institutions in the United States. In effect, it sets up a kind of partnership between the government and the largest firms; they cannot afford to ignore the government’s demands, and the government will have an implicit obligation to make sure they don’t fail.
Prior to this law, competition was the governing mode in the financial industry. It drove institutions to operate efficiently, innovate, take risks and enter new markets. The future will be very different.
The Fundamental Flaws Remain
William K. Black, an associate professor of economics and law at the University of Missouri–Kansas City, is a former top federal financial regulator. He is the author of “The Best Way to Rob a Bank is to Own One.”
The regulatory bill does not address the primary drivers of our recurrent, intensifying financial crises. The only issue is whether the next crisis will have hit by 2011.
The perverse incentives that cause recurrent, intensifying crises remain in place.
There are four major problems now that could kick off the next crisis as early as next year. China is a huge commercial real estate bubble with banking practices so awful that they would make Lehman look competent in comparison. We cannot do anything to save China and when her bubbles burst, and the only issue is timing, they will remove the engine of recovery that many nations are counting on to pull them out of the Great Recession.
The euro zone problems are already at crisis levels in Greece, Spain, Portugal, Iceland and Latvia. Germany’s policies are acting as a brake on the recovery of all of Europe. Spain is one giant residential and the commercial real estate bubble, and its banks are a shambles. The “austerity” programs will take Spain’s unemployment (already 20 percent — 40 percent for young workers) up to levels that will cause the government to fall.
We Need Rules, Not Regulators
Nicole Gelinas, a contributing editor to the Manhattan Institute’s City Journal, is the author of “After the Fall: Saving Capitalism from Wall Street — and Washington.”
A year from now, we’ll find Wall Street completing its transformation into a conduit not of markets but of politics. As financiers at companies like Citigroup and Goldman Sachs listen to what Washington wants, they will remain unable to respond to what the economy needs.
Wall Street will be able to game this new regulator easily.
Over the past two years, Washington has veered inconsistently from financial bailout to financial sacrifice and back again. The government, under two administrations, has had no predictable way through which failed Wall Street firms could go bankrupt without endangering the entire economy.
Specifically, Washington has long allowed Wall Street to take on too much debt through “safe” derivatives and structured-finance transactions, usually related to homeowner or consumer borrowing. When it turned out those investments weren’t so safe, financial firms had taken on so much debt that they couldn’t go bankrupt without taking the rest of the economy with them.
Not Tough Enough on Derivatives
Rob Johnson is a senior fellow and the director of the Project on Global Finance at the Roosevelt Institute. He was formerly a managing director at Soros Fund Management and at the Bankers Trust Company and served as chief economist of the Senate Banking Committee.
The Senate bill is a hope and a prayer that regulators will do better next time.
Artificial incentives ensure that derivatives will still be too widely used.
The essence of the bill is to increase reporting of information from financial firms, and to put faith in the discretion of the Federal Reserve and the new Financial Services Oversight Commission to resist the will of Wall Street to prevent a disaster. I would prefer more rules and less regulator discretion. After all, the regulators failed last time. And alas, this legislation does not make significant structural change, particularly in the derivatives market.
The derivatives market is the San Andreas fault of our financial system. The commingling of guarantees to our “too big to fail” banks, with the use of their balance sheets as the platform of the over-the-counter markets, is dangerous for taxpayers. The guarantees lead to underpriced insurance that encourages overuse of derivatives. The Senate bill contains no change in the law that gives derivatives priority over other elements of the capital structure when a firm fails. That artificial incentive ensures that derivatives will still be too widely used.
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