Tougher financial rules that seemed inevitable after last year’s crisis have been stymied by industry lobbying, government turf battles and a stabilizing banking system. If efforts to tighten oversight of the industry fail, some financial analysts fear a future crisis is inevitable.
Each of the crises of the past 25 years — the collapse of the savings and loan industry, the Internet-stock bust a decade later and last year’s credit-market meltdown — were the result of inadequate regulation, says Eugene Ludwig, a former bank regulator who worked in the Treasury Department during the Clinton administration.
“The failure has been government’s inability to restrain bubble growth, and then often reacting with the wrong medicine,” he says.
The administration’s financial plans focus on the right issues, but some don’t go far enough, he says. Financial experts who are more critical of the plan say it largely consists of half-measures that aren’t likely to rein in excessive risk-taking by banks.
Among other things, the administration’s plan would do away with one bank regulator, but leave multiple agencies in charge of bank supervision. It calls for collaboration between the Securities and Exchange Commission and the Commodity Futures Trading Commission, but stops short of combining the agencies — even though their missions are increasingly similar. And the administration would impose more controls on the largest banks’ risk-taking, but would still view them as “too big to fail.”
Some modest steps have been taken. Congress passed a bill restricting certain activities of credit card issuers. And investment banks have been forced to reduce the amount of borrowed money they can use when making bets.
But the most powerful changes sought by the Obama administration — such as the creation of an agency to police consumer products, including mortgages and credit cards — face an uncertain future.
President Barack Obama, whose plan has yet to get off the ground in Congress, renewed the push for financial reregulation in a speech on Wall Street Monday. His proposals would “make certain that markets foster responsibility, not recklessness” and “reward those who compete honestly and vigorously within the system, instead of those who are trying to game the system,” he said.
The pace of negotiations in Congress will pick up in the weeks ahead. Democrats, who have been consumed by the health-care debate, want to complete a financial overhaul bill by the end of the year.
The first piece of legislation to be taken up by the House Financial Services Committee will be the creation of the consumer product agency. The idea is opposed by bank lobbyists, Republicans and some conservative Democrats who say it will drive up costs for businesses and consumers.
Fed Chairman Ben Bernanke and Federal Deposit Insurance Corp. Chairman Sheila Bair also have criticized the proposal. Bernanke says the Fed is now making consumer protection a core mission. Bair would prefer that a new agency have rule-writing authority but leave enforcement to existing agencies, including hers.
Rep. Barney Frank, D-Mass., who leads the House Financial Services Committee and largely supports Obama’s plan, will begin marking up the bill in October.
In the Senate, Obama’s plan faces tougher criticism and more likely revisions.
Senators from both parties, including Christopher Dodd, D-Conn., chairman of the Senate Banking Committee, dislike the Obama proposal that would give the Federal Reserve more power.
Obama’s idea is to make the Fed the supercop on the lookout for “systemic risks” to the financial system. Opponents say the Fed didn’t recognize the housing bubble until it was too late and therefore shouldn’t be entrusted with greater oversight.
Several senators want to see more of that power to go a council of regulators including the SEC, the FDIC and others. Obama’s plan would establish a council too, but only as an advisory panel.
In the past, financial crises have typically led to broad regulatory changes. The SEC was created in 1933 to protect investors as the Great Depression deepened. The Glass-Steagall Act the same year forced the separation of commercial and investment banks and created an insurance safety net for savings accounts. Scandals involving Enron, WorldCom and others led to the Sarbanes-Oxley reforms in 2002 aimed at broadening corporate disclosures.
This time, the administration says it wants to make changes so sweeping they will prevent a repeat of last year’s crisis — something earlier reforms failed to do.
In the years leading up to last fall’s meltdown, few raised alarms about the risks of reselling pools of subprime mortgages through the global financial system — or of expanding markets for complex products whose risks were hard to calculate.
Before the crisis, then-Fed Chairman Alan Greenspan had argued that markets can generally regulate themselves. He ignored warnings about the housing bubble, including from Bair and Fed Gov. Edward Gramlich, both of whom called for tougher oversight of subprime lending as early as 2001.
In October, three years after leaving the Fed, Greenspan told a congressional panel he had “found a flaw” in his thinking. He said he had relied too much on market forces and hadn’t recognized the destructive potential of subprime lending.
Many experts say the Obama administration’s plan addresses the right issues — tightened oversight, limiting risk-taking at the largest firms and higher capital requirements — but aren’t tough enough to prevent the next collapse. These people say the Obama administration hasn’t proposed the kind of fundamental reform that would prevent another crisis, in part because those changes would meet unstoppable political opposition.
“Are they doing anything to prevent big financial firms from going wacko again and sticking us with the bill?” says Simon Johnson, a former chief economist at the International Monetary Fund and now a management professor at the Massachusetts Institute of Technology. His answer: “Nothing.”
The failure of Lehman Brothers last fall showed how deeply a large, interconnected firm could damage the global financial system. Its bankruptcy, followed by the government bailout of insurance giant American International Group Inc., set off a panic. Lending froze up.
The problems spread so fast partly because the government had no way to deal with large financial firms at risk of insolvency. Smaller banks are seized by the Federal Deposit Insurance Corp. and sold to another bank or dissolved. By contrast, regulators have no tool to end the ties that bind huge Wall Street banks to other banks worldwide.
The administration wants to create a system for winding down these firms. It would be modeled on the FDIC approach to smaller banks. But it would give Treasury the power to put the banks under the government’s wing.
Other proposals face their stiffest opposition from regulators trying to protect their turf. One would have combined bank supervision into a single agency, replacing the existing patchwork of regulators.
Before the crisis, banks that chafed at heavy oversight by their current regulator could apply to be regulated by another, less strict agency.
Industry groups and experts say a single bank regulator would stop banks from exploiting differences among the agencies and lower costs to banks and consumers. The approach also is favored by other advanced economies, like England’s.
But territorial fights among regulators proved too great an obstacle, and the Obama administration dropped this idea. Instead, its proposal would eliminate only one regulator: the Office of Thrift Supervision. Banks would still answer to one more of these agencies: a renamed Office of the Comptroller of the Currency, the FDIC, the Fed and state bank regulators. And if the consumer agency is created, they’ll face yet another supervisor.
“The administration made a calculated decision,” says Ellen Seidman, former Director of the Office of Thrift Supervision and senior fellow at The New America Foundation. “They pulled back on making the plan comprehensive in order to make it fast and politically doable.”