More Regulation is Better
By Austin Monroe
Columnist
I reject the basic premises of the argument that banks are capable of regulating themselves and that regulation hinders growth in the financial sector.
The facts of history simply don’t support that belief. The banks have proven through their own irresponsible actions that they are incapable of adequately regulating themselves – especially in the derivatives and securities markets.
I believe that only through new regulations, like those recently implemented by Obama’s Treasury Department and derided in the space, will banks be able to grow in a stable and sustainable way.
One could spend 4,000 words, or perhaps even pages, on this subject and barely even scratch the surface. The consensus of almost every economist, from right to left, is that our current economic meltdown can be directly attributed to a combination of the ineffectiveness of our previous regulatory framework and the over-leveraging/over-securitization practiced by our leading financial institutions which left their balance sheets sorely undercapitalized.
Smith could never have imagined in his wildest dreams the “financial products” like credit default swaps invented by Wharton MBAs and enabled by laissez-faire legislators such as Phil Gramm, the former republican U.S. Senator from Texas, who almost single-handedly ensured passage for the Gramm- Leach-Bliley Act of 1999. This legislation allowed commercial and investment banks to consolidate and led to many of them becoming “too big to fail.” But Gramm wasn’t done doing his damage yet.
In the Commodity Futures Modernization Act of 2000, Gramm made the future destruction of our financial institutions certain by railroading through legislation which banned federal regulation of “over the counter” derivatives and later, much more exotic and convoluted derivatives like “credit default swaps.”
Gramm was John McCain’s chief economic advisor at the beginning of the campaign until a company called AIG finally self-immolated due to the devastation wreaked by the meltdown of their credit default swap portfolios, forcing Gramm to “go spend more time with his family.”
AIG’s swift fall cost U.S. taxpayers up to $180 billion to ensure payments for AIG’s collateral obligations. That’s more than the combined funding for the U.S. Departments of Education, Veterans Affairs and Health and Human Services in the 2009 federal budget. Just think. Gramm could be disastrously advising a McCain administration right now. Thank God that is not reality. I’ll take Larry Summers having our president’s ear on economic policy any day over Phil Gramm.
The derivatives market has become tantamount to Las Vegas style gambling over what the price of debt is worth. Proponents of derivatives trading say that these instruments help spread risk across the entire market. However, the industry’s exponential growth, created by the over-leveraging of “assets,” was not sustainable. These complex instruments made financial institutions “too interconnected to fail” and would have created a domino effect throughout the entire industry if banks like Bear Sterns were allowed to fail.
That’s why Henry Paulson, Bush’s Treasury Secretary, stepped in and bailed out Bear Stearns in 2007. At the very least, it is in the public’s interest to regulate and demand transparency from these institutions – the very ones which have shown a penchant for self destruction when only regulated by the free market. These huge institutions, Iike AIG and Bear Stearns, have become so interconnected and intertwined that they possess the chilling ability to severely diminish the quality of life that we Americans have become accustomed to if they fail.
It is reasonable to disagree over the structure of the new regulation. But others’ suggestion that the financial institutions who were the root cause of the current recession need less regulation is naïve at best and intellectually dishonest at worst. Indeed, it is becoming increasingly clear that regulation is not a stranglehold choking the life out of capitalism; rather, it is the right amount of restraint and transparency required now for its survival and eventual growth.
The only thing naive here is your ignorance of the root problems of the financial crisis. You reject the idea that banks can regulate themselves yet are totally fine with Obama’s plan to give the biggest bank in the world (the Federal Reserve) more power to regulate a problem that it causes simply by existing.
You also are totally oblivious to the fact that regulations mean nothing if banks are constantly allowed to borrow funds at rates below market levels. Whenever banks get into trouble, the Fed pumps money into the system that shouldn’t be there in order to give the banks more liquidity, causing the malinvesment which has crippled our economy. The only thing sweeping regulations do is to root out competition by making it more expensive for smaller firms to compete with the larger firms that have caused all the problems. Do you think the $3.5 million dollar a year cost of compliance with Sarbanes Oxley means much to a Forturne 500 company? No. But it can cripple new market entrance. Therefore, your solution to the Too Big to Fail syndrome is more regulation that limits competition for the ones deemed Too Big to Fail.
You are totally blind. The US economy hasn’t been a free market for about 100 years now. If the free market had been in place, this crisis wouldn’t have happened because these financial institutions would not have had the money to invest in such risky ventures as derivatives. However, you’re politicians brainwash you into believing that the free market caused all this. Think about that for a second before you go spouting off rhetoric that the same politicians have been saying for years now. Why on earth would such greedy people invest millions of dollars in assets that were so risky they lost all their money? Usually greed means you want to make money not lose it. The answer is because the government lowered interest rates through the Fed and made it possible for financial institutions to borrow money at ridiculously low rates. They had to put that money somewhere to earn profit, and since there were no more safe avenues to invest in due to market restrictions, they had to invest that money in more risky assets. Thereby causing the malinvestment we have now.
And your solution to this problem is give the institution that allowed these banks to invest billions into unsafe avenues more power over our economy! But that is the attitude you get when you allow yourself to buy into the two party system. I mean, Ben Bernanke, the Fed chairmen, has been wrong about every prediction he has made. Upon the eve of the financial meltdown he was saying the economy was as strong as ever. And you want him to try to fix this. It’s like rounding up sheep.
You’re also wrong, by the way, when you say every economist agrees that our regulatory framework was the problem. However, the economists that didn’t predict the crisis are saying that. Yet the Austrian economists, who predicted everything that has happened, blame the Federal Reserve and scold regulation for blinding people from the true problems. Yet, of course, you’re too smart to listen to the ones who were right about everything, aren’t you? I mean, they’re just naive and dishonest right?
Next time, before you go talking about how history has proven your point, you might want to actually understand the history. Go back in your history book to 1913 and look at the financial monster that was created during that year and you’ll find the root cause of all the economic problems we are having now. You really need to educate yourself a bit more on this issue.
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