The Heritage Foundation

The Morning Bell


MONDAY, SEP 14, 2009


Don’t Enable The Financial-Regulatory Complex



This Saturday, tens of thousands of Americans marched on Washington to protest the unprecedented amount of power being concentrated in Washington, DC under the Obama administration. And even the New York Times admits they have a point: “The government is the nation’s biggest lender, insurer, automaker and guarantor against risk for investors large and small. Between financial rescue missions and the economic stimulus program, government spending accounts for a bigger share of the nation’s economy — 26 percent — than at any time since World War II.”
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And on the Sunday New York Times op-ed page, George Mason University professor of economics Tyler Cowen writes:



For years now, many businesses and individuals in the United States have been relying on the power of government, rather than competition in the marketplace, to increase their wealth. This is politicization of the economy. It made the financial crisis much worse, and the trend is accelerating. … President Dwight D. Eisenhower warned of the birth of a military-industrial complex. Today we have a financial-regulatory complex, and it has meant a consolidation of power and privilege. We’ve created a class of politically protected “too big to fail” institutions, and the current proposals for regulatory reform further cement this notion.



President Barack Obama will be pitching those very financial regulatory reforms today from Federal Hall, where the founders once argued bitterly over how much the government should control the national economy. Unfortunately, the blueprint for financial regulatory reform issued by his administration is a detailed mixture of overreaching policy mistakes, missed chances for real reform, blanks that will be filled in later after studies, and a few good ideas.

The President and Congress should:


Avoid Making the Federal Reserve Serve as Systemic Risk Regulator: The Obama Administration proposes to put the Federal Reserve Board in charge of regulating systemic risk, but it is not clear how such regulation would work in practice or even if this method is the best way to approach the problem. Charging a single entity with reducing systemic risk is likely to raise false expectations. It is very doubtful that any systemic regulator will be able to successfully fill this role unless it has almost unlimited powers, and this type of open-ended power would be difficult to constrain and should be resisted.
Do Not Create a Consumer Financial Protection Agency: The administration proposes to consolidate existing consumer regulators into a new and very powerful Consumer Financial Protection Agency. This is the single biggest policy mistake in the Obama plan. The proposal assumes that consumers are unable to understand any financial products other than the most simple, basic versions even with detailed disclosures in advance of purchase. This basic contempt for the intelligence of consumers would extend to requiring them to refuse certain basic products before they would be allowed to purchase anything else.
Resist Giving the FDIC Resolution Authority for “Too Big to Fail” Financial Firms: Dealing with failing financial companies that could cause risk to the financial system is a valid concern, but the Administration’s approach seems more geared toward facilitating future bailouts and justifying additional intervention. Clearly, a receiver/conservator that can operate the least certain subsidiaries until they can be sold or orderly closed is necessary in order to maximize returns to debtors. But the Treasury plan assumes that the Federal Deposit Insurance Corporation (FDIC) should handle this role rather than allowing the courts to determine a receiver and then supervise it.


Instead of a Washington-centric top-down approach, the President and Congress should pursue a more modest approach. Rather than giving a government agency the ability to take over and operate large financial institutions, bankruptcy law ought to be modified to accommodate the special problems of resolving these firms and also allow the courts to appoint receivers with the specialized knowledge necessary to best deal with their failure. Instead of creating a regulatory scheme that results in the federal government financing 9 out of 10 new mortgages, Fannie Mae and Freddie Mac should be eliminated. And rather than seeking to micro-manage “too big to fail” financial institutions, it would be better to require them to have more capital than is required for smaller financial institutions.