Arianna loves most of the ideas in our book, "The Road From Ruin," with one notable exception: she thinks we are not in favor of the "muscular regulation" of finance that she thinks is essential. We think a better way to characterize our position is that massive regulatory reform is needed -- just not the insipid brew that Washington seems determined to give us.
Take this week's latest proposals from Senator Chris Dodd. Yes, he did better than the little expected of a man who personifies the conflicts of today's Congress. (He helped pass some of the reforms that got the financial system into its current mess, has received millions in campaign donations from Wall Street, and got a cut-price mortgage from Countrywide, on a special deal offered to VIP "friends of Angelo" Mozillo, its CEO.) In fact, Dodd's proposals were actually quite good, by Washington's standards. The trouble is that Washington's standards just are not good enough.
What Dodd has put on the table will barely scratch the surface, given the changes that are needed to build a regulatory system that actually works.
Let's be clear. We like the idea that someone will be responsible for monitoring the overall level of risk in the system. We just don't think that Dodd's high council of regulators chaired by the Treasury Secretary will do the trick. Wasn't the Treasury Secretary supposed to be doing that already?
It is easy to imagine this becoming just another layer of ineffective bureaucracy, much like putting a new Department of Homeland Security on top of the existing security apparatus after 9/11. Indeed, with the Treasury Secretary in the chair, would this council really face down the political leaders and try to stop an emerging bubble spreading a feelgood factor across the nation (as bubbles do, before they burst)? Even in his pomp Alan Greenspan knew that a Fed chairman couldn't risk being too gloomy about the economy and keep his job. What chance then of a Treasury Secretary, a cabinet member, being so bold?
Rather than another layer on top of the dysfunctional existing regulatory system, America needs to sweep away its absurd proliferation of regulators and replace them with a powerful super regulator, independent of day-to-day politics and empowered to do the job properly. America has far too many regulators -- AIG, the insurer that helped nearly destroy the financial system in September 2008, had over 50 regulators in America and over 400 worldwide, none of which seems to have spotted what a financial weapon of mass destruction it had become.
At the very least, the SEC and the CFTC, which overlap confusingly, should be merged. Yet all Dodd proposes is to scrap the Office of Thrift Supervision. Could such feebleness have anything to do with the fact that different regulators tend to be monitored by different Congressional committees, none of which is likely to favour the loss of campaign funds that would accompany a regulator's abolition?
Of course, even a super-regulator would come under political pressure. So let's shore it up with an independent agency to investigate the causes of financial crashes and propose solutions, similar to the National Transport Safety Board that investigates air crashes. Unlike a congressional enquiry, this agency staffed by people who actually understand finance (alarmingly thin on the ground in the current regulators, such as the SEC) would be free from the pressure of lobbyists and the conflicts of campaign finance.
Effective regulation also means thinking outside the Wall Street box and focusing on the needs of Main Street. Consumers clearly need better protection from the rapacious predators of the finance industry. We favour making the teaching of financial literacy a key part of the school and college curriculum, and we'd like to see consumers required to answer a series of questions to ensure they understand what they are doing before they are given a mortgage or college loan, say.
But that alone would not be enough without a regulator determined to seek out and destroy mischief hidden by banks in the small print. Dodd proposes a consumer protection agency -- but wants it to be a part of the Federal Reserve, where it would be likely to have its sword blunted by the conventional wisdoms of central bankers and economists (no doubt with Wall Street whispering in their ears). The Fed already has many powers to protect consumers that it manifestly failed to use. Consumer protection is just too important to be left to the Fed.
As for the out of control pay on Wall Street and elsewhere in the boardrooms of corporate America, Dodd rightly sees that shareholder power is the key to change, by proposing a "say on pay" vote. Yet it will only be an advisory vote -- "we'd rather you didn't pay yourselves so much" -- that could easily be ignored, especially because Dodd proposes to do nothing to give shareholders meaningful powers to replace underperforming boards, nor to do anything to require institutional shareholders that invest the public's retirement savings (pension funds and mutual funds) to take seriously their fiduciary responsibilities on corporate governance and long-termism. A start would be for the government to make it clear that these institutions will in future be judged (and sued by the government if necessary) by their long-term results and behaviour, not their short-term performance against the markets.
After a crisis the temptation is always to fix the symptoms rather than the root causes. The lesson of history, as we explain in depth in "The Road From Ruin," is that this leads to regulations that lull us into a false sense of security when they, in fact, are sowing the seeds of the next crisis. That is why we are wary of ideas like the Volcker Rule, to stop deposit-taking banks engaging in risky trading, or setting arbitrary restrictions on financial innovation. We fear that these simple rules will not stop the reckless risk-taking, just displace it to somewhere else in the global financial system where there is less regulation. (And another big hole in Dodd's plan is the lack of any serious effort to tackle some of the flaws in global regulation that contributed to this crisis.)
We believe that putting consumers and shareholders, rather than bank executives, in the driver's seat is the best way to stop the financial folly on Wall Street. We need real leadership in Washington, willing to muscularly reform a financial establishment seemingly determined to resist change at all costs. What is currently on offer just won't do. Toxic politics as much as toxic finance got us into this mess. Cleaning up Washington has got to be the first step if we are to choose The Road From Ruin rather than the road to stagnation and decline.
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