Over the past two years, we have faced the most severe financial crisis since the Great Depression. The financial system failed to perform its function as a reducer and distributor of risk. Instead, it magnified risks, precipitating an economic contraction that has hurt families and businesses around the world… This current financial crisis had many causes. It had its roots in the global imbalance in saving and consumption, in the widespread use of poorly understood financial instruments, in shortsightedness and excessive leverage at financial institutions. But it was also the product of basic failures in financial supervision and regulation.
Our framework for financial regulation is riddled with gaps, weaknesses and jurisdictional overlaps, and suffers from an outdated conception of financial risk. In recent years, the pace of innovation in the financial sector has outstripped the pace of regulatory modernization, leaving entire markets and market participants largely unregulated. That is why, this week – at the president’s direction, and after months of consultation with Congress, regulators, business and consumer groups, academics and experts – the administration will put forward a plan to modernize financial regulation and supervision… In developing its proposals, the administration has focused on five key problems in our existing regulatory regime — problems that, we believe, played a direct role in producing or magnifying the current crisis.
While I think I might have conceptualized the problem in this way as an old outdated system in need of modernization, the truth is that the system was manipulated by a series of shortsighted changes that were motivated by the financial greed of many under the guise of "a free market economy." The system didn’t break. It was broken by people for personal gain.
First, existing regulation focuses on the safety and soundness of individual institutions but not the stability of the system as a whole. As a result, institutions were not required to maintain sufficient capital or liquidity to keep them safe in times of system-wide stress. In a world in which the troubles of a few large firms can put the entire system at risk, that approach is insufficient. The administration’s proposal will address that problem by raising capital and liquidity requirements for all institutions, with more stringent requirements for the largest and most interconnected firms. In addition, all large, interconnected firms whose failure could threaten the stability of the system will be subject to consolidated supervision by the Federal Reserve, and we will establish a council of regulators with broader coordinating responsibility across the financial system.
After the Great Depression, Congress passed the Glass-Steagall Act introducing the separation of bank types according to their business [commercial and investment banking], prohibiting large mergers, and initiated the Federal Deposit Insurance Corporation for insuring bank deposits. While it was a crisis-driven maneuver, it turned out to be a wise move. It protected our savings from speculators. Our Capital stayed safe drawing interest from the that paid by borrowers. Investment Institutions were clearly identified and closely watched. Beginning with the Reagan Presidency, the Glass-Steagall Act was slowly dismantled creating the huge financial institutions that ultimately speculated us into last year’s system collapse.
Geitner’s solution diverges from F.D.R.’s. Rather than blocking the formation the huge financial institutions [Capitopolises], he’s proposing that we identify them and watch over what they’re doing. This proposal recognizes the advantages of having such institutions in a global and national economy, but aims directly at the dangers – like the ones that brought us down this time.
This is a "gift" to the Conservatives. They’re going to look this "gift horse in the mouth," but to hell with them. This is not Socialism, this is sensible thinking. It’s the only solution to the down-side of a free-market economy – a free-market economy with "hall monitors."
Second, the structure of the financial system has shifted, with dramatic growth in financial activity outside the traditional banking system, such as in the market for asset-backed securities. In theory, securitization should serve to reduce credit risk by spreading it more widely. But by breaking the direct link between borrowers and lenders, securitization led to an erosion of lending standards, resulting in a market failure that fed the housing boom and deepened the housing bust. The administration’s plan will impose robust reporting requirements on the issuers of asset-backed securities; reduce investors’ and regulators’ reliance on credit-rating agencies; and, perhaps most significant, require the originator, sponsor or broker of a securitization to retain a financial interest in its performance. The plan also calls for harmonizing the regulation of futures and securities, and for more robust safeguards of payment and settlement systems and strong oversight of "over the counter" derivatives. All derivatives contracts will be subject to regulation, all derivatives dealers subject to supervision, and regulators will be empowered to enforce rules against manipulation and abuse.
There’s little to say about this principle. It’s essential in all dimensions. Risk is not something to be bought or sold. The real commodity is credit. This principle is well thought out and well presented. Kudus to Geitner, Summers, and their "handlers."Third, our current regulatory regime does not offer adequate protections to consumers and investors. Weak consumer protections against subprime mortgage lending bear significant responsibility for the financial crisis. The crisis, in turn, revealed the inadequacy of consumer protections across a wide range of financial products – from credit cards to annuities. Building on the recent measures taken to fight predatory lending and unfair practices in the credit card industry, the administration will offer a stronger framework for consumer and investor protection across the board.
Consumers and Investors need to be protected from predatory lending as they say, sure enough. But Consumers and Investors also need to be protected from themselves. Human greed is kind of like sex. Abstinence hasn’t worked in the past and it won’t work in the future.Fourth, the federal government does not have the tools it needs to contain and manage financial crises. Relying on the Federal Reserve’s lending authority to avert the disorderly failure of nonbank financial firms, while essential in this crisis, is not an appropriate or effective solution in the long term. To address this problem, we will establish a resolution mechanism that allows for the orderly resolution of any financial holding company whose failure might threaten the stability of the financial system. This authority will be available only in extraordinary circumstances, but it will help ensure that the government is no longer forced to choose between bailouts and financial collapse.
No more Alan Greenspan, Ayn Rand-esque fiscal gyrations. It was something of a "Wild West" way of running the show based on a thesis of endless growth. Instead of juggling things to keep them in the road, they are proposing that we use the techniques of preventive medicine – early detection and prompt intervention. More excellent thinking. I can’t wait for the moping tanning salon addict [John Boehner] to say, "Oh, my god!"Fifth, and finally, we live in a globalized world, and the actions we take here at home – no matter how smart and sound – will have little effect if we fail to raise international standards along with our own. We will lead the effort to improve regulation and supervision around the world. The discussion here presents only a brief preview of the administration’s forthcoming proposals. Some people will say that this is not the time to debate the future of financial regulation, that this debate should wait until the crisis is fully behind us. Such critics misunderstand the nature of the challenges we face. Like all financial crises, the current crisis is a crisis of confidence and trust. Reassuring the American people that our financial system will be better controlled is critical to our economic recovery.
Obviously, the devil is in the details, but these principles are sound and well targeted toward the causes of the problems. Rather than coopt F.D.R.’s plan from 80 years ago, they’ve tailored this one to the modern world. In spite of their concessions to the Conservative side, we’re sure to hear cosmic moans about Big Government and Socialism. We can’t really blame them. It’s just their nature.By restoring the public’s trust in our financial system, the administration’s reforms will allow the financial system to play its most important function: transforming the earnings and savings of workers into the loans that help families buy homes and cars, help parents send kids to college, and help entrepreneurs build their businesses. Now is the time to act.Timothy Geithner is secretary of the Treasury. Lawrence Summers is director of the National Economic Council.
I haven’t been in love with either Geitner or Summers [both sound kind of boring when they talk]. But this op-ed moves them up more than a couple of notches because it’s clear, simple, and very right-thinking. Everyone is worried that the Obama Administration isn’t "progressive" enough. I don’t care about that. I want them to be "sensible" enough. These are the most sensible of principles. I give this op-ed an A. I’ve been worried that they wouldn’t take on the whole task for fear of the political consequences. Instead, they seem to be bravely going where no one has gone before [aka the right direction]…
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