Normally dour Larry Kudlow had a funny, telling line on CNBC yesterday. Responding to news that a bankers association had put out an economic forecast calling for recovery in the 3rd quarter, Kudlow dryly noted that if the forecast was accurate, "the banks will be right about one thing in a row."
The financial services sector has been jaw droppingly wrong on many things during the course of the financial crisis -- especially, to Alan Greenspan's infamous "shocked disbelief," when their own self interest was at stake.
If the banks and financial services industry oppose the Obama financial overhaul , the track record will remain untouched. The reflexive reaction of the industry to push back against any regulatory action is in full force (see this foaming at the mouth reaction). But a closer look at the Obama plan reveals that the proposed overhaul is, by and large, in the best interests not only of consumers of financial products, but the financial companies themselves, their shareholders, and investors.
1. Confidence Is King: Recovery of the financial markets has been prolonged by a failure of confidence among investors and consumers. The mortgage markets remain shut down, absent an on-going huge transfusion of capital by the federal government. Trust in the ratings agencies has evaporated. We should take it as a sign when Chinese students laugh down the US Treasury Secretary's assertion that assets held by American institutions are safe -- they are the next generation of international investor. Meanwhile, consumer lack of faith in banks is at an all time low, with a recent survey finding only 9% of US and UK borrowers expressing confidence in financial institutions.
How Obama Plan Addresses: The Obama Plan lays out a series of steps designed to restore investor and consumer confidence. The securitization process -- which went seriously awry with the off-loading of risks of garbage products -- gets rebooted. For the first time, loan level data must be disclosed to ratings agencies and investors -- not only at the issuance of the security, but on an on-going basis so that investors can track the actual performance of the underlying loans (a process known as surveillance, pioneered by companies like Clayton Holdings). Ratings agencies will be subject to tighter conflict of interest rules and improvements to the integrity of the ratings process. On the consumer side, the proposed Consumer Financial Protection Agency would mark the separation of consumer protection from safety and soundness banking regulation. Consumer protection has typically been on the backburner of the banking agencies, as evidenced by the Fed's after-the-fact discovery of a subprime problem. If an enhanced consumer protection regime is the price of regaining borrower trust, it will be worth it for the struggling financial industry.
2. Standardization and Uniformity: The financial services industry is notoriously subject to inconsistent and conflicting regulatory requirements from a number of agencies. For example, the rules governing mortgage closing are administered by HUD and the Fed (Truth in Lending Act, and Real Estate Settlement Procedures Act) and have resulted in a situation that benefits neither lenders nor borrowers, as HUD Secretary Donovan recently noted. The cost and burden of compliance of these conflicting requirements is enormous.
How Obama Plan Addresses: The plan would integrate regulation for the Truth in Lending Act (TILA), Home Ownership and Equity Protection Act (HEOPA), Real Estate Settlement Procedures Act (RESPA), Community Reinvestment Act (CRA), Equal Credit Opportunity Act (ECOA) and Home Mortgage Disclosure Act (HMDA). By creating a "one stop shop" for mortgage and finance regulation, the CFPA can help bring coherence and rationality to a regulatory system that today is fragmented and difficult to comply with.
3. A Level Playing Field for All Financial Players: The fragmentation of regulatory authority in today's system sometimes creates competitive disadvantages for financial industry participants. Identical products may be subject to different regulatory requirements, depending on who regulates the lender, leading to confusion for consumers and unfairness for lenders.
How Obama Plan Addresses: The plan would "ensure that banks, nonbanks, and independent mortgage brokers all play by the same rules", with a mandate for the CFPA to "write rules across bank and nonbank firms for a level playing field". We can't remember a prior instance of the federal government paying heed to a "level playing field" for the financial services industry.
4. Plain Vanilla Rules for Plain Vanilla Products: One of the absurdities of today's system of regulation is that the level of disclosure and restriction is the same for a relatively simple financial product like a conforming 30 year fixed loan as it is for an "exotic" product. That traditional system serves neither borrowers -- who can be inundated with voluminous but not necessarily meaningful disclosures for simple products, while not getting enough transparency on complex financial products-- nor lenders, who bear the costs and burdens the system.
How the Obama Plan Addresses: Obama economic advisor Michael Barr pioneered the application of "behavioral regulation" to mortgage and consumer finance lending. Many of Barr's concepts have found their way into the Obama plan. The CFPA would have authority to define standards for "plain vanilla" products that are simple and have straightforward pricing -- significantly easing disclosure standards for the vast majority of products. Lenders could offer more complex products, but the disclosure would be commensurate with the complexity -- a novel approach that stands to benefit lenders and consumers.
5. Obama Plan is A Politically Moderate Approach: The Obama plan is far from the radical restructuring of markets or imposition of "command and control" regulation that many in the finance industry feared. If anything, the plan is notable for what it does NOT do:
- The plan does not revamp the credit rating agency business model (i.e. to an investor pay model)
- Does not create a "super regulator" for systemic risk
- Mutual fund regulation stays at SEC, not the new consumer agency
- The plan does not create federal insurance regulation
- The plan does not attempt an overhaul of Fannie Mae and Freddie Mac
Generally, the plan is more "course correction" than a top-to-bottom shakeup of financial markets. The plan is not without cost and not without flaws -- it will and should be refined and improved during the legislative debate to come. But the overall proposal is helpful to the stability of financial services industry and the confidence of investors and borrowers -- without turning the banking and financial world upside down. The question is, does the industry know a good deal when it sees one?
This commentary solely reflects the views of The Glaser Group, a financial services and mortgage industry consulting firm.
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