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Wednesday, June 17, 2009

We Must Oppose the President's New Regulatory Framework

I haven't read the entire thing yet but the parts I read force me to oppose this framework. The two places within this new framework that will ultimately become a totaly nightmare involve the new regulatory framework that governs those companies that pose a "systemic risk" and also the new regulatory body that will help fight predatory lending.

As I suspected, the president gave a new regulatory body sweeping new powers to regulate any firm that posed a systemic risk without defining any limits on that power. The Financial Services Oversight Council will be created. It will consist of members of Treasury, the Fed, and other regulatory bodies and it will maintain an office with the Department of Treasury. It will "fill in gaps in supervision, facilitate coordination of policy and resolution of disputes, and identify emerging risks in firms and markets." Beyond this, the Federal Reserve will go from regulating merely banks to any financial institution that has a bank as part of its portfolio.

Then, the Fed, in conjunction with this new committee, will engage in policies like "hold a firm's subsidiary to a stricter prudential standard than would be required by the functional regulator". Are you confused? So, am I. The regulatory authority throughout the white paper is so vague, like the example given, that ultimately, this new body can do just about anything.

By the Fed now having more oversight responsibility for firms with "systemic risk", it also means that this can allow the Fed to use its new role as an extension of its monetary power. (by increasing or decreasing the capital requirements of said institutions). It should be noted that this authority is required to be shared by the Fed along with the rest of the council, in consultation, but ultimately, the only limit on all of this new power is that the Fed must consult with the rest of the council before making any final decisions.

What the president has thus done is created a new regulator. Given that regulator all sorts of vague powers, and created almost no limits on these powers. This is a recipe for a regulatory body that ultimately gets drunk on power and becomes a burden on the system. The Endgangered Species Act is one example of a regulatory body with similarly vague regulatory power that used those powers to spin out of control.

At the same time, the Fed is now limited in its power to open up its Fed window in emergencies. They will now need to get Congressional authority to lend. This is interesting and surprising. I believe this is largely a red herring. The fed window is open to any bank that needs or wants to use it. This is a passive power. In other words, it's only open if the bank wants to use it. So, limiting the Fed's authority to lend in this window will absolutely limit its authority in this area. At the same time, this is not one of the Fed's main powers. It's also unclear whether or not the Congress will act as a rubber stamp, an unnecessary nuisance, or a real and true watch dog in this role. I am not terribly confident that the Congress will know which borrowing request is good and which is frivilous.

The second frightening part of this is the portion of the regulatory framework that creates the Consumer Financial Protection Agency. This body will be able to do just about anything it wants in the name of protecting the consumer that engages in just about any financial transaction.

As such, all mortgage rules HMDA, RESPA, TIL, etc. now fall under the jurisdiction of this new body. At the same time, the new regulatory framework allows individual states to continue to set guidelines above and beyond that of CFPA. This, of course, betrays the stated goal of creating the CFPA, "to promote consistent regulation of similar financial products". The same financial product can still have different sets of regulation across state lines. Furthermore, ultimately, all this is is yet another regulatory body competing with all the regulatory bodies already out there.

The Department of Justice, the Office of Banks and Real Estate, and the SEC, to name just three will still have some authority over mortgages and credit cards and they will now have to coordinate that authority with yet another regulatory body. They have broad responsibility to create transparency in both mortgages and credit cards. The limits on this authority are vague. As I have said more than once, to close a mortgage you need to sign about a hundred documents. How much more "transparent" can you get? This body will be allowed to act outside of Congressional laws to create any new regulations on transparency. This will no doubt lead soon enough to doubling the number of pages signed at the closing.

Finally, I am no expert on the problems in credit cards, but I am an expert on the problems in mortgages. The problem was never a matter of a lack of regulations or a lack of regulatory agencies. It was a lack of enforcement. The bulk of the problems with sub prime loans were a product of fraud. That's already illegal. There are already plenty of bodies with authority over this. None of them enforced it. Creating a new agency to create new regulations won't necessarily mean that enforcement will be any stiffer.

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