EXTEND OLD PRINCIPLES TO NEW MARKETS

January 6, 2010

The centerpiece of the financial reform bill that the House passed this month, following President Obama's blueprint, is a new Financial Services Oversight Council.  It is based on the premise that the credit crisis came about because no single agency had the job of overseeing the whole financial system, says Nicole Gelinas, a contributing editor to the Manhattan Institute's City Journal and the author of "After the Fall: Saving Capitalism From Wall Street -- and Washington."

For example:

  • The new regulator would seek to remedy this perceived deficiency, identifying and neutralizing potentially grave risks to the financial system before they turn into disasters.
  • Under the House version of the bill, the regulator would have the power to force a "too big to fail" bank to sell its riskiest divisions to reduce the danger it posed to the economy, and would have the power to mandate stricter borrowing rules and the like for supposedly riskier banks.

But such an "omniscient" regulator could not have prevented our current crisis, says Gelinas.  It should not be the job of regulators to assess risk from the top down.  Congress should instead follow the regulatory philosophy that served the nation well for 50 years after the Depression: Set consistent limits on borrowing across similar financial instruments, no matter what their perceived risks.

For example:

  • Borrowing limits in the housing market would have protected the economy.
  • As the bubble expanded, people would not have been able to keep up with a requirement for, say, a consistent 20 percent down payment, thus dampening demand.
  • And when the bubble burst, it would not have left behind so much unpaid debt.

Consistent borrowing limits eliminate the need for a vast bureaucracy to micromanage the financial system -- a bureaucracy that could be captured by powerful companies.  Such limits would also help solve the too-big-to-fail problem, says Gelinas.

Source: Nicole Gelinas, "Extend old principles to new markets," TwinCities.com, December 31, 2009

For text:

http://www.twincities.com/opinion/ci_14103680 

 

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