In case you were starting to feel good about the outcome of the financial reform debates, here's a bold prediction: The reform bills making their way through Congress will not prevent another crisis. Who knows whether it will be next year, the year after, or five years from now? But it will happen eventually, for two very powerful reasons: Complacency and Complexity. Let me explain.
I'll start with a reminder that the financial meltdown that we experienced almost two years ago was just one more in a long series of banking-related crises over the past few decades (or more). Over this period we've had bubbles and bursts related to "least developed country" (LDC) loans, commercial real estate lending, the savings and loan collapse, Asian currency speculation, dot-com exuberance, and now subprime extravagance. As Gilda Radner's character from the original Saturday Night Live used to say, "It's always something!"
The reality is that the combination of human behavior and market forces is much more powerful than any legislation. Eventually creative financial engineers will find new ways to satisfy market needs (and make money) in the context of any "reformed" system. This will inevitably create completely new and unforeseen opportunities and issues. Unless the government and regulatory system is continually vigilant about these innovations, we'll have the makings of another crisis. Unfortunately, the passage of the current "landmark reforms" doesn't do anything to force the regulatory system to get ahead of the game. In fact, it does the opposite by focusing regulators on making sure there isn't a reoccurrence of the last crisis. So we end up looking backwards and in our complacency will likely miss the next bubble and burst cycle.
To compound the situation, the financial reforms that are likely to take effect do not reduce regulatory complexity and fragmentation, which was one of the central causes of the most recent meltdown and many previous crises. As I've noted in an earlier post, there are currently dozens of agencies or institutions that have a role in regulating the U.S. financial system (not to mention foreign regulators). In addition, there are standard-setting organizations such as the Financial Accounting Standards Board; rating agencies such as S&P and Moody's; and market organizations such as the New York Stock Exchange. With so many organizations each looking at different sets of data through different lenses with different agendas, it's no wonder that problems and patterns fall through the cracks.
Regrettably, the financial reform bills do nothing to simplify this system despite long-standing calls for doing this from people such as JPMorgan Chase CEO Jamie Dimon, who said last year that the regulatory landscape needs to be simplified. Instead, the current reforms reinforce fragmentation by strengthening many of the current regulatory bodies, giving them more powers and budgets, while also adding a consumer protection agency. This is not to say that the reforms are misguided or will be ineffective at curbing the practices that got us into trouble two years ago. However, they are focused on attacking individual problems (e.g. derivatives trading and mortgage disclosures) rather than creating a simpler and more integrated architecture for regulating the financial system as a whole.
So will we have another crisis? Absolutely -- unless we push our political leaders for more forward-thinking regulatory planning and simpler overall solutions. What do you think?
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