Commentary

Watch Out for the Big Bad Fed

While the Iranian theocracy cracked down on mass dissent after they rigged the latest presidential election, the Obama administration announced major plans to revamp the regulatory architecture of the financial services industry. It seems as if the developments in Iran greatly overshadowed the American public’s interest in how the financial markets will operate in the years ahead. That is a shame, because the revamping of the federal government’s regulatory powers over the waste-strewn field of finance will affect Americans much more than the desperate actions of crusty Mullahs clinging to power in Iran.

The Washington Post summed up the Obama administration’s plans on Wednesday:

The Obama administration last night detailed a series of proposals to involve the government more deeply in private markets, from helping to steer borrowers into affordable mortgage loans to imposing new limits on the largest financial companies, in a sweeping effort to curb the kinds of reckless risk-taking that sparked the economic crisis.

I see two major problems with the Obama administration’s proposals to save American finance, and the consumers who still, unfortunately, are addicted to their toxic products.

The first is the expanded role of the largest player in the proposed regulatory structure, the Federal Reserve, which is detailed in the same article from the Washington Post:

The administration’s plan leans heavily on the Fed, expanding its role as the regulator of the nation’s largest banks such as J.P. Morgan Chase and Goldman Sachs to include other giant financial firms, such as the insurance companies American International Group and MetLife. The agency, which has greater independence from the political process than other regulators, would have broad authority to impose special requirements on those companies, such as mandating that they set aside a larger percentage of their assets against possible losses than smaller firms. Such a requirement could limit large companies’ appetite for risk, but also their profit and growth.

The plan calls for a council of regulators to consult with the Fed, including the Treasury secretary and the heads of the other financial regulatory agencies: The Securities and Exchange Commission, Commodity Futures Trading Commission, the Federal Housing Finance Agency and the agencies that regulate banks. A primary task of the council would be to recommend which large, globally interconnected firms are too big to fail and should be subject to more rigorous oversight. But the council will not have the authority to oppose decisions made by the central bank.

I happen to share some of the views of Mike Shedlock of Mish’s Global Economic Trend Analysis about the Federal Reserve’s ability to be proactive by nipping another financial crisis in the bud before it lays waste to global markets and the American economy. Shedlock points out that the Fed did not see the financial crisis coming, and they added fuel to the credit bubble by keeping interest rates freakishly low for way too long – I strongly agree with both criticisms. (But he advocates abolishing the Federal Reserve altogether, which I believe is a ridiculous suggestion because it would increase instability in the financial markets over the long haul.)

The second major problem lies a proposed mandate of the brand new Consumer Financial Protection Agency. Regulating the way loans are marketed and sold is an idea that is very sound, but as the Washington Post points out:

…the agency would have a mandate to increase the availability of financial products in lower-income communities and other underserved areas, in part by enforcing the Community Reinvestment Act (CRA), which requires banks to make loans everywhere that they collect deposits.

I also share the sentiment of MIke Shedlock on the enforcement of the CRA to make banks offer loans wherever they take deposits. Shedlock points out that this was an essential ingredient to the urban subprime loan disaster. This is what helped push Fannie Mae and Freddie Mac to the brink of insolvency. Politicians encouraged the federal mortgage giants to make loans to unqualified buyers so they could buy homes they couldn’t afford. (It’s easier than providing proper eduction and job training that eventually lead to a higher standard of living and increased purchasing power.)

I must elaborate on this last point of criticism of the Obama administration’s plan. I believe that everyone should be allowed equal and fair access to credit. But forcing lending institutions to make bad loans does two dangerous things. Number one, it lets politicians off the hook with regard to providing meaningful improvements to the lives of nation’s poor. During the inflation of the housing bubble, Congress focused on offering easy credit instead of offering opportunities to better education and training – and they will most likely do the same again this time around. The second nasty outcome of such weasel-like policies is that the American taxpayer will have to absorb the losses when people with poor credit can no longer service their loans.

I am very aware of the fact that subprime lending DID NOT CAUSE the financial crisis, which lead to a massive, panic-driven bailout of the banking industry. It was merely a symptom of the disease (which was a mix of greed and ignorance of risk) that created the credit bubble and the consumer spending and real estate booms. But encouraging any form of the bad behavior that provided nutrition to the reckless lending practices of the past few years should be cast on the pile of bad ideas, not implemented under the banner of social justice.

I will sum up my criticisms of the Obama administration’s proposed financial regulatory overhaul. The expansion of the Federal Reserve’s power to deal with troubled financial institutions removes transparency and accountability from the process. The Fed’s mandate to provide full employment will ultimately clash with it’s new responsibilities to keep large financial institutions in line. The Federal Reserve should not be abolished, but it certainly should not be encouraged to continue making trillion dollar deals behind closed doors. And, forcing banks to make lousy loans will only increase risk to the financial system while at the same time ignoring the real issues facing America’s poor communities.

For more on the state of the financial system and the comical “bank stress tests,” read my piece called “Bank Stress Tests are a Complete Farce!”

Here are some worthy articles on this subject:

“Sheila Bair is on Your Side,” from the Nation. (Bair runs the Federal Deposit Insurance Corporation, and is the nemesis of Treasury secretary Timothy Geithner and many Wall Street sycophants.)

“Obama: Government’s role is to unleash creativity in markets,” from Marketwatch.com. (This articles discusses the expanded role of the Federal Reserve in putting out future financial fires.)

“Federal Reserve to gain power under plan,” from The Washington Times. (This piece also offers more details and insight into the Fed’s new role as top financial regulator.)

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