Ian Goldin, Guest Columnist
Ideology: Left-Independent | Writing In: Buffalo, NY
On Tuesday, Federal Reserve chief Ben Bernanke was grilled by congress about his plans to expand Fed authority to police large financial companies. One of the main parts of President Obama’s campaign platform was “Not more regulation – better regulation.” And on Wednesday, during his speech on health care, Obama talked about the need to mitigate risk to the financial system to save our economy. So why, in Obama’s financial regulatory “overhaul,” does it only require retention of five percent of the credit risk on sold securities? One of the main catalysts that caused the financial crisis was the lack of regulation of the securities market.
A security, for those who aren’t up to date on financial jargon, is really just something that represents financial value, and they come in different categories. The category we’re concerned with is debt securitization – when loans are bundled together and sold to investors. Just before the financial crisis, banks and investors were selling bad securities – bundles of risky loans, including mortgages on homes with artificially inflated values. The rest is history. The housing bubble burst, making people default on their mortgages, making the securities worthless, making the banks bankrupt.
To prevent such a thing from happening again, the administration’s new financial regulations were supposed to provide disincentives to prevent investors from selling bad securities. Now, firms that originate mortgages will be required to retain five percent of the credit risk after it is sold. That’s a good start, but why don’t banks that securitize the loans have to retain any of the risk when they sell them? This sort of slicing and dicing of loans is where the real regulation is needed. Why five percent? Why not fifteen percent? Five is a completely arbitrary number, and it’s not nearly enough – especially when applied to the banks. The banks need to have a stake in their risky transactions. That’s the only way to prevent the kind of risky behavior that results in systemic meltdown.
This is not an example of “better regulation.” But that’s not entirely the fault of the Obama administration. The problem is that it’s nearly impossible to find regulators with the expertise required to regulate the financial industry. The financial industry is unique: it changes not by the day, but by the hour. Investors are always looking for the next big thing, creating new markets within the financial structure. This makes for a difficult situation. The only experts with the know-how to successfully regulate the financial industry are the insiders – the ones working within the industry itself. That presents a conflict of interest. The industry insiders can’t be allowed to be the sole regulators because they have too much incentive to regulate in favor of the industry – which usually turns out to be unfavorable to the general public. To quote the movie Wall Street, “If you’re not inside, you’re outside!”
I don’t know how to solve this dilemma, but I do know that increasing the powers of the Federal Reserve is not the solution. Not only is the Fed the most non-democratic institution of the Federal Government, but their actions contributed to the situation we are in today. What we need is what Obama promised: Not more regulation, better regulation.