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Thursday, March 26, 2009

Some Thoughts on the Beginning of the New Regulatory Framework

Treasury Secretary Geithner laid out some broad principles today for a significant increase in new regulations of the financial sector.

The Obama administration is proposing an extensive overhaul of financial regulations in an effort to prevent a repeat of the banking crisis last fall that toppled once-mighty institutions and wiped out trillions of dollars in investor wealth.

Congress would have to pass new rules to regulate the market for credit default swaps and other types of derivatives and require hedge funds to register with the Securities and Exchange Commission.


Let me be clear," Geithner added. "The days when a major insurance company could bet the house on credit default swaps with no one watching and no credible backing to protect the company or taxpayers must end."

The program the administration was presenting to Congress includes a recommendation for creation of a systemic risk regulator, possibly at the Federal Reserve, to monitor risks to the entire system.

There is a lot here I agree with. It's long past time that Hedge Funds and Private Equity Firms become more transparent and this will go a long way toward doing that. That said, such regulations often have unintended consequences. McCain/Feingold lead directly to the proliferation of 501 (C)3's. In much the same way, such regulations of Private Equity and Hedge Funds can, and in my opinion will, lead to the proliferation of other financial services firms that aren't regulated. Furthermore, it also means that hedge funds and private equity firms will likely move off shore to places where the regulations aren't as stiff.

I also agree that credit default swaps are desperate need of regulation (I have called for this as well), however, in my opinion, the market is a much better regulator of such markets. Once markets like credit default swaps collapse, the market is usually much more ruthless than any regulation. I suspect that most of the regulations that the government will propose have already been created by the market. In fact, I suspect that credit default swaps are rarely used at this point entirely.

I can support a systemic risk regulator. I am also in favor of figuring out a way to stop too big to fail. I am, however, troubled that the Obama administration wants to allow the government to step in and take controlling interest in any company deemed too big to fail. In fact, I was concerned myself about making such regulations a power grab.

To update Sherman to include companies that are too big to fail would consolidate an obscene amount of new power in the hands of the government. As such, a new law would have to be narrowly defined to determine just how it would be determined that a company is truly to big too fail.

So far, this regulation is rather vague and vague regulations lead directly to the government consolidating far too much power. There needs to be something done to prevent further companies from becoming too big to fail, but it must be much more specific than it is now.

Finally, most disappointing is that while there is a plethora of new regulations in the financial industry there is no new regulations for Fannie/Freddie. Given that the company owns and runs both now, they might see them is not needing regulations, but in fact they are both in desperate need of it. I have proposed breaking them up and privatizing them however that is the antithesis of what is going on now. Their reform is not necessary for a vibrant financial system but it is vital for a vibrant real estate market. Hopefully, their reform is coming soon.

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