Three Cheers for Stability

Whether You See It as Too Much or Too Little, At Least Obama’s Financial Regulations Overhaul Focuses on Protecting the Little Guy

Recent polls indicate that voters who supported President Obama last November are becoming increasingly nervous he is trying to take on too much too fast. Obama seemed to acknowledge their concerns and his own limitations with an eighty-eight page white paper issued by his Administration this week, aimed at overhauling regulations for the U.S. financial industry.

In truth, “overhaul” is far too generous a term for what Obama is proposing. It more accurately represents an extensive, sometimes contradictory, set of tweaks, born of compromise and a realized need for diminished expectations, which plug the worst of the loopholes leading to our current economic mess while leaving others in place.

Those hoping for streamlining and simplification were most disappointed. A gallimaufry of overlapping federal and state agencies will continue watching the bubbling pot containing an over-garnished stew of banks and financial institutions. Obama’s proposals eliminate only the relatively minor Office of Thrift Supervision by merging its functions with those of other agencies.

The Federal Reserve lies at the heart of the give and take. On the one hand, its powers expand by allowing it to regulate non-bank financial institutions, such as AIG. On the other hand, the Fed must first acquire approval from the Treasury Department before providing loans to institutions in particularly dire circumstances. What is more, a proposed Consumer Protection Office would completely usurp its control over mortgage loans.

The President attempted to cast his Administration as Solomonic by declaring, “We are called upon to put in place those reforms that allow [capitalism’s] best qualities to flourish – while keeping those worst traits in check.”

Former SEC Commissioner Laura Unger suggested a more realistic pragmatism at work. “As the debate played out, they realized it would be near impossible to get wide, sweeping reform enacted. I think they wisely chose the safer path.”

The Banking Industry generally reacted with dismay to Obama’s proposals. Republican Senator Bob Corker of Tennessee, a member of the Senate Banking Committee, best encapsulated the chief counterargument against additional regulation. “I think there will be some debate as to whether . . . there should be a totally separate entity [for consumer protection] that could, in fact, stifle innovation.”

Peter Wallison, a senior fellow at the American Enterprise Institute, agrees. Writing in the Wall Street Journal, he feels the Obama Administration “fears the ‘creative destruction’ that free markets produce, preferring stability over innovation, competition and change.”

Given the events leading up to last fall’s wide scale economic meltdown, it seems to me that a little less creativity in the financial industry might be a highly welcome if much belated occurrence. Accountants and economists created the illusion of growth where no real growth existed – along with its accompanying superior products and job creation – by their ability to manipulate balance sheets and devise new types of questionable securities.

For his part, Paul Krugman of the New York Times, feels Obama makes a good start but does not go nearly far enough in regulating financial markets. He applauds Obama’s proposals for “[bringing] non-bank banking out of the shadows” but complains the white paper “highlights ‘compensation practices’ as a key cause of the crisis but then fails to say anything about addressing those practices.”

The innovation over which free market proponents are so worried is important but it often requires research and development, trial and error, long-term investment, and patience. Yet this is exactly the opposite of what markets rewarded throughout the 1990s and the first decade of the Twenty-First Century. Instead, they insisted upon ever-expanding growth and profitability without regard as to what was driving them. Analysts all but wrote off companies performing below their projections for even a single quarter, let alone suffering losses due to risk taking.

Such unreasonable expectations led to the faux growth practices described above. They also gave rise to a breed of CEOs and senior executives able to generate several quarters to several years of spectacular faux growth, with corresponding spectacular compensation, before bailing to another firm and leaving stockholder with the inevitable following misfortune.

As Obama noted in his speech outlining his proposals, “Executive compensation – unmoored from long-term performance or even reality – rewarded recklessness rather than responsibility.”

Many have decried the government’s role easing the bankruptcies of GM and Chrysler, arguing they deserved to fail for creating cars that nobody wanted to buy. This is far too simplistic. Both automakers, particularly GM, carved profitable niches churning out the heavy, polluting, gas-guzzling SUVs, vans, and trucks that Americans loved to buy until environmental concerns and $4.00 per gallon fuel prices provided a long overdue wakeup call.

The U.S. auto industry’s problem was not a failure to understand their current market and respond to it but failure to understand or even think about the needs of future markets, blinded all too easily by shortsighted greed. Their problem was not making cars that nobody wanted to buy but rather opting for the easiest cars for them to make that everybody wanted to buy.

“The bottom line is the regulators failed; it wasn't the regulation,” says Dean Baker, co-director of the progressive Center for Economic and Policy Research. “I would say if we want to prevent the next bubble, we have to hold the people accountable for this bubble. So fire them.”

It is hard to disagree that many prominent heads ought to role over all that has transpired. However, should Obama choose to pursue such a course, it will be up to the Justice Department to prosecute, rather than expecting Treasury, the Fed, and other agencies to police their own. Worse, this attitude tends to forgive underlying systemic problems by placing blame on “a few bad apples.” We need something more sweeping.

“You can’t go back to the regulatory agencies that didn’t act because we know that doesn’t work and didn’t work,” said John Taylor, president of the National Community Reinvestment Coalition, who worked with the administration in drafting the new rules. “We need an independent agency whose mission is this and only this, who are really worrying about whether the consumer, the taxpayer is being tricked, cajoled, cheated, hoodwinked and is being treated fairly enough.”

Incomplete although they may be, the best argument for Obama’s proposals may well be that the banking industry hates them while consumer advocacy groups have generally cheered. A focus on defending the little guy is a concept Obama promised to bring back to government. After trillions of dollars to help bail out huge corporate players, the little guy is finally getting their day.

For years, it was taken almost as a given that private enterprise, although it might sometimes be ethically challenged, could always be counted upon to run any organization or function better than the bureaucratic, inept federal government. Given the economic wastelands where private enterprise’s emphasis on short-term greed has left us, it seems they have abdicated their competency along with the moral high ground.

This is a notable insight to consider as Congress takes up not only regulation of the financial industry but an overhaul of health care as well. Three cheers for stability.