Proposed Republican regulatory reform

A week ago Wednesday loyal reader Nate asked me to comment on a news story which detailed House Republicans’ plans of regulatory reform. I apologize Nate but it has taken me awhile to get to the story. In summary, House Republicans proposed:

1 Failing companies would be directed into bankruptcy rather than bailouts.

2 The Federal Reserve would lose its ability to regulate the financial industry.

3 They oppose the creation of a systemic risk regulator (systemic is financial industry jargon for risk that is not unique to an individual business, but to the entire financial system)

4 They also oppose resolution powers of the government (in other words, official power to bailout troubled firms)

5 Creation of a “Consumer Protection and Market Stability Board” that would monitor the economy for regulatory gaps and issue reports to regulators and with no enforcement powers

6 The Government Accounting Office would be granted oversight and audit over the Federal Reserve

7 Lastly, the plan would merge the Office of the Comptroller of the Currency and the Office of Thrift Supervision

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Alright, let’s take these in turn…

1 I am strongly in favor of this first proposal. I was opposed to the bailouts last fall. The reason is that capitalism only works well in the long-term if there is a fear of failure. Fear of failure leads to businesses taking only those risks that seem appropriate and that ensure the continuity of a business. Bailouts tell market participants that they can take inordinate risks no matter the consequences. I also believe in the long-run bailouts plant the seeds for additional bailouts. The analogy is to people who are irresponsible. If their parents continually bail them out of poor choices there is no incentive for the people to ever learn responsibility. Does this make sense? I find it interesting that there is Republican support of an anti-bailout movement given that they were supporters of a bailout when a Republican president was in office. Why the sudden switch?

2 I am not sure what the justification is for stripping the Federal Reserve of its regulatory oversight. No reason is given. In general, I think that having regulatory oversight that is separate from Congress is a good thing as it provides a nice check and balance to an institution, Congress, that is politically-centered. So I oppose this suggestion.

3 As strongly as I support #1 above, I am against this point of view. Of all of the regulatory changes that are necessary to prevent a future financial meltdown of the epic proportions we have witnessed, the creation of a systemic risk evaluator is the most important. As it stands now, no one regulator can see the total risk in the financial system and whole, large swathes of financial market activity are absolutely invisible to regulators. What that means is that policies and regulatory actions are undertaken blindly. I am blown away that Republicans would be against the creation of a regulator that would be granted better vision. I am guessing that their opposition falls under the “we are Republicans and we hate regulation and government interference” mantra; aka we are the “laissez faire” party.

4 I think it is useful that the government have some resolution authority. Someone, somewhere has to be the backstop. What I think would be useful is if the conditions for use of government resolution authority were absolutely spelled out and unambiguously.

5 This is an absolutely useless proposal and I think meant to confuse the public into thinking that Republicans are actually interested in some form of oversight. This proposal is utterly toothless and consequently useless and the Republicans know it. It’s not often that Republicans and Europeans are on the same politically impotent page. See our discussion of proposed EU regulatory changes to see why #5 should be buried.

6 This is a great idea. Currently the Federal Reserve is set up as a private corporation (a not well known fact). This was done to ensure the independence of the Federal Reserve system from political preferences – also a great idea. However, as we all know, checks and balances do work. If the Fed is eventually subject to oversight it will be very important that whomever is granted that authority is actually funded well by Congress – otherwise the oversight will be as meaningless as the SEC’s oversight of the financial markets has been in the last decade.

7 Again, I am not sure why this specific suggestion has been made other than to end the ala carte nature of regulation that allowed businesses to shop for the regulation and regulator that best served its interest. To me, you either create one overarching financial market regulator (my preference) or you empower the current regulators to actually do their jobs. So I am opposed to this proposal without more information.

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I am very open to fielding questions from any of you who read the blog. I created the blog because so many friends and family were asking me questions that it was getting tedious telling the same stories over and over again. The idea is to have a dialogue between each of you and me. So keep them questions comin‘!

Jason