Congress is missing its opportunity to restore accountability, transparency, and market discipline now lacking in our financial system. Instead it has chosen to rip apart the very fabric of our capital markets: the ability to invest and grow through capital formation. With the Senate poised to pass its consequential financial regulatory overhaul, the complicated policy details have been kept at a distance from the American people – demagoguery has again displaced debate; political pandering has trumped sound economics.
The campaign-style approach to every legislative effort is a disservice to our legislative process. Like the health care debacle, those with legitimate concerns are cast as villains – impugning the motives of the opposition, while dismissing alternative solutions. For millions of American families, the real pain from the past financial crisis can still be felt; it is critical that we get it right.
The fundamental architecture of the financial regulatory overhaul expands and centralizes power in Washington, and exacerbates the root causes of the crisis. The sweeping array of new councils, agencies, and bureaucracies fails to decouple America’s economic well-being from the fate of a select few financial firms. Unprecedented authority over the operations of financial institutions would be vested in the Federal Deposit Insurance Corporation (FDIC). The FDIC would be authorized to seize risky financial institutions if a council of regulators, chaired by the Treasury Secretary, believes a company is in danger of default and poses systemic risk. Once a company has been seized, the FDIC oversees its entire resolution process, including restructuring the order of creditor obligations – serving as creditor, manager, and referee.
Conflicts of interest will inevitably arise on how to treat creditors of failed firms. Winners and losers would be determined by the arbitrary discretion of government bureaucrats, inviting entrenched corruption and dispelling the market discipline of our profit-and-loss free enterprise system. The broad authority vested in government agencies fosters greater uncertainty for American companies already facing a hostile tax and regulatory environment.
The Senate bill affords countless opportunities for big government and big business to collude – what I call crony capitalism – at the expense of smaller-sized competitors, consumers, and taxpayers. Institutions deemed “too-small-to-succeed” would not be afforded the explicit protections given to the largest firms, resulting in higher borrowing costs and higher hurdles to succeed relative to their well-connected competitors. Perverse incentives will arise as financially sound companies would take on open-ended and unpredictable tax burdens, which would fall onto the millions of American customers and investors in these companies.
Despite roughly 1500 pages of legislative text, the destructive role of the government-backed housing giants remains a glaring omission. Enabled by Congress, Fannie Mae and Freddie Mac wrought havoc on the housing market and remain on operational life support as taxpayers subsidize their failure. After their leading role in the sub-prime mortgage crisis, they’ve received $145 billion in taxpayer dollars, with hundreds of billions more on its way. Fannie and Freddie demonstrate just how big federally blessed and guaranteed businesses can grow – and just how hard they can fall.
A number of key corrections to mitigate the path of destruction from crony capitalism’s wake have been rejected throughout the Senate debate. Senator John McCain, for example, offered an amendment to end the privatized profit/socialized loss model of Fannie and Freddie, phasing out costly taxpayer subsidies. House Republicans have also put forth serious reforms for Fannie and Freddie, as part of our larger financial reform alternative – despite being shut out of the process in House.
There is no shortage of innovative alternatives to the heavy-handed government approach. Oliver Hart of Harvard University and Luigi Zingales of the University of Chicago have offered an innovative proposal that gets at the “too-big-to-fail” question. Rather than arbitrary government seizure, Hart/Zingales suggest a market-based trigger that tells firms when to beef up capital. Credit default swap spreads would determine the probability of default, and the buffer would be broken into two levels of capital: basic equity and junior long-term debt. The Hart/Zingales approach is aimed to better balance “the need to curb reckless risk-taking…while making sure not to unduly constrain economic activity, investment and growth.” (Hart/Zingales)
The frenzied timeline in Congress is aimed at scoring a legislative victory prior to the November midterms – neglecting the importance of engaging the American people in the policy disputes and forging consensus addressing the root problems. The Financial Crisis Inquiry Commission, for example, has been essentially cast aside by the very same Congress that tasked the commission to investigate the crisis and issue its report later this year. The Democratic leaders on both ends of Pennsylvania Avenue have opted to rush a bill to the President’s desk now, putting ideological goals and campaign strategy ahead of the catalyst for financial reform: making certain the crisis of 2008 never happens again.
The federal government has a critical role to help ensure financial markets are fair and transparent, and to hold accountable those that violate the rules. Reform should aim to restore the principles which have made credit available to American families and entrepreneurs and our capital markets the envy of the world: freedom to participate, an unbreakable link between performance and reward, continued attachment to risk, and a sense of responsibility that ensures those who reap the gains may also have to bear the losses.
This misguided overhaul is the latest threat to the American engine of prosperity – a threat that we cannot afford.
This article available online at: http://www.realclearpolitics.com/articles/2010/05/20/wall_street_reform_just_more_crony_capitalism_105659.html