“Your No. 1 Client is the Government”
September 19, 2013, 7:22 p.m. ET
The Government Won on Financial Reform
The financial system is more regulated than ever, but also no safer.
The truth is that across the U.S. economy the government has far more power than it did five years ago, especially in finance. The same politicians and regulators who pulled every lever they could to force capital into mortgage finance have not only escaped punishment for their role in the 2008 crisis. They’ve also awarded themselves more authority to allocate credit. Consider some prominent realities:
• Most of the big banks survived, but at the price of becoming regulated utilities. A sensible reform would have been to require more capital as a bumper against losses, and to use a basic definition of capital that can’t be gamed. Instead, the regulators are requiring more capital while adding vast new layers of regulation.
The regulation micromanages bank decisions down to the kind and quality of loan. Regulators have ordered a top-to-bottom overhaul of foreclosure processes even after extorting more than $25 billion in payouts for exaggerated past offenses.
The Consumer Financial Protection Bureau can veto some products while all but dictating certain kinds of lending. The bureau already has 1,297 employees and an automatic budget tied to Federal Reserve System expenses, not to Congressional appropriations.
• The policy of too big to fail has been codified and expanded. Dodd-Frank lets Washington’s wise men define “systemically important” institutions subject to stricter regulation, and they are dutifully expanding this safety net. Insurance companies are already in this maw (AIG, Prudential) or may be soon (MetLife). So are clearinghouses for derivative trades, which have emergency access to the Federal Reserve’s discount window.
Dodd-Frank’s second great conceit is that in a crisis these firms will be wound down without a rescue. They even have to provide “living wills” that are supposed to plan the funeral. But the law also gives regulators the freedom to protect creditors as they see fit, which they will surely do in a panic. The difference next time will be that more firms will be deemed too big to fail.
• The government roots of the crisis are unreformed, especially easy credit and the bias for housing. The Federal Reserve keeps buying mortgage securities to lift housing prices. Fannie Mae and Freddie Mac continue as ever, even after losses resulting in $188 billion in bailouts. Taxpayers now guarantee close to 90% of all new mortgages either through Fan and Fred or the Federal Housing Administration, which may also need a bailout.
Now that Fan and Fred are making money again amid the housing recovery, political pressure is growing to release them from federal conservatorship. This would recreate the same toxic mix of private profit and public risk that made them so dangerous when we were warning about them a decade ago.
Dodd-Frank did mandate that credit-rating agencies be reformed, but regulators still haven’t finished the job. The same goes for money-market mutual funds, which continue to benefit from a government rule that lets them declare a $1 net asset value even if the value of the underlying assets has changed. This is systemic risk caused by government that government could but won’t fix.
Even the new Basel capital standards are suspect because they include a carve-out for sovereign debt. So the same regulators that claimed mortgage debt was AAA safe now say that debt from various governments is solid gold.
The simpler, better reform would have been to require much tougher capital standards for banks that take insured deposits, set clear rules that limit risk-taking at such institutions, and let other companies innovate and take risks knowing they get no taxpayer protection. Instead, five years after the panic we have a financial system that is more heavily regulated, and thus is less able to lend and innovate, yet is paradoxically no safer. The government won again.