Facing the blank sheet of paper that will eventually be the chronicle of his life in government and the success or failure of the Administration�s programs to radically overhaul the regulation of the financial world, Larry Summers, the intemperate former President of Harvard, said something that he and his colleagues will regret. �Every important problem that was a contributor to past crises, and every import
ant problem that we believe is potentially going to shape future crises, has been addressed,� he told Bloomberg TV. Put more succinctly, we are gods and not men.
Summers� comments were part of his barnstorming for The White House�s new set of proposals to oversee American financial markets, large institutions, mitigate the risk of complicated derivatives, and give Americans an advocacy program to defend them from financial predators. Summers makes the assumptions that experience is an infallible guide to predicting and influencing the future.
Summers, a brilliant economist and former Treasury Secretary, knows better. The Federal Reserve Act of 1913 did not create an organization that could either predict or prevent the country from the Great Depression. The Treasury Department could do no better. The SEC was created in 1934 and the number of major securities scandals and violations of the national securities laws since then can barely be counted.
A number of catastrophes could have been avoided if each generation of financial regulation had been crafted so well that it could cover every danger and contingency. It would have been easy for the American government to limit bank exposure to Latin American debt during the 1970s. There were no such limitations. When sovereign nations in the region defaulted on their debt, it nearly took Citibank under in 1982.
One of the central pieces of the Administration�s plan is that the Fed, apparently in consultation with the Treasury, will be able to take over and dismantle ! large Am erican financial firms if they are on the brink of failure. That still leaves to human judgment and its potential fallibility the ability to discern which institutions cannot right themselves in a period of trouble. It brings into question how regulators decide what to do with the pieces of a huge private firm that has been taken apart. Risk does not disappear because it has been moved from one large operation into several smaller ones. The toxic pieces still have to be dealt with, properly, if the overall financial system is to be appropriately protected. Human judgment is still the final gatekeeper in that process. A new law will not create generations of prudence.
One of the pillars of the new regulations and regulatory bodies that will be put into place is the �Consumer Financial Protection Agency.� It will be this agency�s job to make sure that the average citizen is not faced with predators which would try to overcharge for lending him money or managing his retirement account or try to market him a mortgage he cannot afford. One of the issues going forward is whether financial firms can reasonably charge fees for the risk that they take doing business with consumers. The housing market will never recover if banks cannot make money on mortgages and granting mortgages is a process which is, by its nature, very risky during a recession. Banks need to set rates to offset and mitigate that risk. The mortgage business will become a dicey way for banks to make money if the government elects to keep consumers happy by lowering their costs of living at the expense of the profits of the financial system.
Looking back on the new programs several decades from now, historians may have to admit that the new regulations that were proposed today did fix the financial system and created a series of laws that were so perfect that the system could not be broken again. It would be the first time in recorded history that a government enterprise of long standing only solved problems and never created them. I! t would also be the first time that a large new set of regulations actually anticipated the future path of every institution and action it was meant to regulate, thereby keeping, in this case, the financial system and the consumer completely safe.
None of the current crisis, which nearly overwhelmed the national financial and credit system, would have happened if only the federal government of the 1930s had made its attempts at regulation right in the first place
Douglas A. McIntyre
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