15 Replies Latest reply on Feb 6, 2011 3:09 PM by JerryD

    Financial services regulation

    econguy
      Hi, econguy here. I suspect most financial regulation already in place is more than sufficient. It was lack of enforcement action and of political will that got US economy to brink of collapse rather than a lack of regulation. And certainly the fall was not the fault of business, they just do what their highly paid lawyers and other specialists advise they can get away with to make money under current law, both statutory and administrative.
        • Re: Financial services regulation
          Sensei2001

          As a graduate lecturer in Economics I will go you one step further and say unequivocally that it was the OVER-regulation of our financial industry that precipitated our current depression and probable economic collapse.  In this case, government is the problem; not the solution.  So it terrifies me that 85% of those polled think we don't have enough financial regulation.

          It's fascinating that somehow China can rule 1.5 billion people with an iron fist for only $300 billion a year while the USA spends over $6.5 TRILLION a year to govern 300 million supposedly free people ... something just doesn't add up!

            • Re: Financial services regulation
              JerryD
              Sensei2001 said...

                   
                        

              As a graduate lecturer in Economics I will go you one step further and say unequivocally that it was the OVER-regulation of our financial industry that precipitated our current depression and probable economic collapse.  ...

                              
                        
              Edited 2:37 PM  by  Sensei2001
                   

              I am not big on BIG GOV but won't you concede that some of the loan practices caused many home owners to lose or be about to lose their homes. When loan companies (not all or probably many are banks) don't verify your income and assets or sell you a dangerous product (i.e. nothing down, interest only, etc.) this seems to me to be not prudent and requiring regulation. I was personally aware of some people who were planning to get into mortgages without any experience or banking background. That is NOT a good situation when profits trump appropriate.

              Then how about the financial instruments that even "sophisticated" investors didn't understand? Don't you think that regulators need to step in when these bubbles threaten our economy? Heck, I think that even Warren Buffet mentioned that some thing didn't smell right about these investments.

              Or how about when rating organizations generate revenue from the companies that they are rating? Gosh, that even sounds like conflict of interest worthy of regulation to me.

              Regulation by itself is not bad. What's bad is when you let politicians and lobbyists write the regulations. The experts need to propose the regulations and Congress gets to approve only. But then we also don't want Congress to write container laws that they hand over to regulators that are expected to write the details over the next few years (i.e. health care).



                • Re: Financial services regulation
                  Sensei2001
                  JerryD said...



                  I am not big on BIG GOV but won't you concede that some of the loan practices caused many home owners to lose or be about to lose their homes. When loan companies (not all or probably many are banks) don't verify your income and assets or sell you a dangerous product (i.e. nothing down, interest only, etc.) this seems to me to be not prudent and requiring regulation. I was personally aware of some people who were planning to get into mortgages without any experience or banking background. That is NOT a good situation when profits trump appropriate.





                  Jerry, the situation you described was the result of regulation that incentivized the mortgage industry to make high-risk loans to people who could not pay them back.  That was one of the major components of the whole Fannie-Freddie scandal.  The government decided that it was unfair that people had to qualify for loans, so they provided financial incentives to lenders who loaned money to un- and under-qualified borrowers.  They also provided incentives to lend on properties that were imprudent investments in the name of preventing "red-lining" of areas with falling property values.

                  When the government gets into the business of social engineering through regulation it always spells disaster.  The saying "a fool and his money are soon parted" goes back to the 16th century.  In a truly free society, we must allow fools and their money to be parted.  Foolish lenders and foolish borrowers alike should go broke, with no government agency stepping in to protect either one from the other ... or most of all, from themselves.

                    • Re: Financial services regulation
                      JerryD
                      "Regulation by itself is not bad. What's bad is when you let politicians and lobbyists write the regulations. The experts need to propose the regulations and Congress gets to approve only. But then we also don't want Congress to write container laws that they hand over to regulators that are expected to write the details over the next few years (i.e. health care)."

                      I guess your point agrees with my last statement above that you omitted. There are instances of good regulations, for instance, the regulations that required the replacement of Freon in HVAC systems. The GOV set the goals and let the industry come up with the solutions.

                      I am far from an expert on regulation but after reading the following book by a very smart man who is a MacArthur ("genius award") fellow I modified my attitude about (intelligent) regulation:

                      Saving Energy, Growing Jobs: How Environmental Protection Promotes Economic Growth, Competition, Profitability and Innovation (Paperback) by David B. Goldstein



                      • Re: Financial services regulation
                        ldgpangeo
                        I've read many times the claims that Washington somehow forced the banks to write bad loans to undeserving people, but the details provides often come up weak.   Yes, the fed's advocated broader lending but banks still had the fiduciary responsibility to do it properly.  

                        Just looking at my own community, I see two types of lenders.   The local community bank always was prudent in its lending (aka "old fashioned") and survived this recession with flying colors.  Conversely there were several of mortgage brokers offering absurd deals (nothing down, interest only...   borrow 125% of home value....), many of which folded once the recession hit. 

                        If the Fed's forced, why were smaller banks allowed to ignore them?  Similarly, why were mortgage brokers freely allowed to abuse the system?  In any other time, advising people to lie about their income would be considered fraud. 

                        As we understand this better, perhaps we can craft the right types of regulation that prevents such abuses as we move forward.
                        • Re: Financial services regulation
                          ldgpangeo
                          "In a truly free society, we must allow fools and their money to be parted.  Foolish lenders and foolish borrowers alike should go broke, with no government agency stepping in to protect either one from the other ... or most of all, from themselves."

                          While I philosophically agree with this position, the problem is that when a recession hits everyone bleeds.   For example, I followed all the predictions about a housing bubble and avoided investing in stocks and mutual funds associated with banking, housing, ... as much as possible.   Yet, when the recession hit, I saw my portfolio tank just like everyone else.  Yes, I lost less than those heavily invested on those markets, but that's faint solace when it dives enough to hurt one's retirement plans.

                          Are there ways in this modern world to make the markets less interlinked so that one can truly have the goal of allowing foolish bubbles to explode without massive collateral damage?
                            • Re: Financial services regulation
                              Sensei2001

                              Idgpangeo, you may have noticed that I used the term "incentivized"; not forced.  The feds strongly incentivized imprudent loan practices, but they did not force any lenders to do so.  Instead, greed did the rest.  Under these programs, greedy individuals borrowed money they knew they could not repay from greedy lenders who would never have loaned to them under normal market conditions.  The lenders who took advantage of these programs grew rapidly, attracting more Wall Street capital, while the lenders who did not do so, just plodded along and watched their capital markets dry up.  Anyone could see it was a house of cards just waiting to tumble, but these were government loan programs backed by "the full faith and credit of the U.S. government".  It wasn't long before it was considered imprudent not to participate in these programs.  Directors and CEOs who did not found themselves out of lucrative jobs in the lending industry ...

                              Now, it's easy to say that lenders who participated in these programs were "evil and greedy" for doing so.  But it was really the equivalent of taking a tax credit for insulating your attic or buying a CFC-free refrigerator.  All the "experts" were tellling them they were fools not to.  The government dangled the carrot because they wanted the lenders to take it.  And they would have dangled bigger and bigger carrots until they got what they wanted. 

                              And, yes, everyone bleeds in a recession -- whether it is cause by market corrections or government manipulation.  I also teach graduate finance and if there was a way to avoid collateral damage from market corrections I would tell you.  There isn't.  The best you can do is diversify your investments.  But life is a risk.  Only death is perfectly safe. 

                                • Re: Financial services regulation
                                  ldgpangeo
                                  "And, yes, everyone bleeds in a recession -- whether it is cause by market corrections or government manipulation.  I also teach graduate finance and if there was a way to avoid collateral damage from market corrections I would tell you. "

                                  That's what feels wrong about radical laissez-faire.  It essentially states that foolish investments will happen and there is nothing that can be done to control or mitigate them.

                                  That feels like a highway with no rules or police.   The traffic laws can't stop all accidents but they can reduce them and their impact by stopping inappropriate behavior.  Simply put, I want my police to arrest anyone who drives 90 mph down my residential street because when that person crashes he/she is going to hurt other people.

                                  Is there an economic equivalent?  What can/should the govt regulate in the marketplace?


                                    • Re: Financial services regulation
                                      Sensei2001
                                      ldgpangeo said...



                                      "And, yes, everyone bleeds in a recession -- whether it is cause by market corrections or government manipulation.  I also teach graduate finance and if there was a way to avoid collateral damage from market corrections I would tell you. "



                                      That's what feels wrong about radical laissez-faire.  It essentially states that foolish investments will happen and there is nothing that can be done to control or mitigate them.



                                      That feels like a highway with no rules or police.   The traffic laws can't stop all accidents but they can reduce them and their impact by stopping inappropriate behavior.  Simply put, I want my police to arrest anyone who drives 90 mph down my residential street because when that person crashes he/she is going to hurt other people.



                                      Is there an economic equivalent?  What can/should the govt regulate in the marketplace?





                                      Naturally, there should be laws against criminally negligent behavior, whether by individuals or banks.  Two issues are involved in that:  (1) who should have jurisdiction?  (2) where is the line to be drawn between "criminal" and "legal" behavior?

                                      Using your analogy of speed limits, do we want the FBI, CIA, NSA, and 27 other federal agencies all policing our streets looking for speeders, or should that be a matter for state or local jurisdictions?  And secondly, how closely do we regulate the undesired behavior?  Do we simply make it illegal to exceed a certain speed in a given area, based upon potential exposure to accidents?  Or should we regulate the angle at which the driver's seat is positioned, where the driver's hands are positioned on the steering wheel, how often and how many degrees should the driver swivel his/her head scanning for possible accident risks, how loud the radio can be playing in the car, whether other passengers can be talking while the vehicle is in motion, the maximum PSI at which the accelerator can be depressed, etc., etc.?

                                      We've essentially done the latter to almost every industry in this country and wonder why our economy collapsed.

                                      I remember being indoctrinated in school that "laissez-faire" was wrong and that "caveat emptor" exposed me to exploitation by evil, greedy businesses.  Now with the benefit of 40 years work experience, a doctorate, and 12 years of genealogical research I'm pretty much convinced they were lying to me.  The American economy, and personal wealth in particular, has been in steady decline since 1970 -- oddly enough, the same time that America began its shift from the Industrial Era to the Bureaucratic Era.

                                      You asked what happened after the S&L collapse and I also seem to recall that the government cherry-picked a few CEOs as scapegoats and jailed them.  Then, as now, it's Congress that belongs behind bars ... oh, but wait, they voted themselves immunity from prosecution, didn't they?

                                        • Re: Financial services regulation
                                          ldgpangeo
                                          You make a strong case for not regulating the details of business operation while agreeing that some overall rules (e.g. not speeding) should be enforced.  What would you recommend as examples of appropriate business rules within your framework to avoid getting into the detailed business minutia?


                                            • Re: Financial services regulation
                                              Sensei2001

                                              Good question!  A lot depends on the type of business.  I think there has to be a compelling need for any regulation of a business.  And when there is a need, is that need local, regional, or national in nature.  Going back to the speed limit.  The need is local -- the safety of people exposed to hazardous driving.  So the ordinances and their enforcement should be at the local level.  Taking that analogy to a business ... what about a hardware store would need regulation?  If it sells dynamite, then maybe something to do with safely handling, displaying, and storing dynmate -- i.e., local.  If the local citizens want to impose a sign ordinance, so the hardware store doesn't raise a 2-acre neon sign that keeps the whole town awake all night, fine -- because the local store owner gets an equal vote with all his neighbors in local matters, and they are ultimately his customers, so he's got an incentive to keep them happy anyway.

                                              Now let's look at a lender, since that's what started this discussion.  What needs to be regulated about a lender?  Interest rates?  If they are too high, no one will do business with them.  If they are too low, they'll go broke.  No regulation needed there.  Who they loan to?  What if they won't lend to minorities?  They discriminate!  If the minority customers will pay profitable rates and are reliable, won't somebody come to town and make a nice living lending them money?  I will!  So is regulation really needed, even to prevent discrimination?  Maybe not.  Financial stability?  What if the lender over-leverages?  They'll go broke.  Problem solved.  New, smarter lender will come to town if there's a market.

                                              Ah, but what if the lender grows so big that its failure could damage the entire local, state, or national economy?  In a free market, competition prevents that from happening, doesn't it?  If there's that much profit to be made, many more competitiors will enter the field and prevent any one lender from becoming that large.  It's only when the government steps in and eliminates choices -- by establishing minimum or maximum lending rates, entry restrictions, etc. -- that we have to worry about a company getting so big it can topple an economy.

                                              As you can see, I'm clearly not in favor of very much regulation.  I want to be free to make both good and bad decisions and live with the consequences of each.  And I think that the majority of regulation of every kind should revolve around public safety, rather than protecting stupid people.  As an economist, I have trouble justifying the concept of punishing the 84% of people who are reasonably smart in order to protect the 16% who are stupid.  The cost-benefit simply isn't there.

                                              I am willing to live with economic reality of a free market -- and that reality is that 3% of the populace will become fabulously wealthy, 13% will be upper-middle class and live well above the average, 68% will live modestly, 13% will be working poor, and 3% will be charity cases ... but all (except those very few with diminished capacity due to birth defect, injury, disease, or trauma) will end up where they end up by their own choice.  And I recognize that not everyone would agree with me.

                                                • Re: Financial services regulation
                                                  ldgpangeo
                                                  Thank you for a very interesting, clear, and informative statement of the situation.  Thank you for taking the time to compose these messages.

                                                  I got lost in only one paragraph:

                                                  "Ah, but what if the lender grows so big that its failure could damage the entire local, state, or national economy?  In a free market, competition prevents that from happening, doesn't it?  If there's that much profit to be made, many more competitiors will enter the field and prevent any one lender from becoming that large.  It's only when the government steps in and eliminates choices -- by establishing minimum or maximum lending rates, entry restrictions, etc. -- that we have to worry about a company getting so big it can topple an economy."

                                                  A truly free market then prevents any player from getting too big.  I was always taught that the trust-busters of the early to mid 20th century were created precisely because some companies had become big enough to control the marketplace to the point of preventing competition.  Was that era a temporary aberration?  Was trust-busting a mistake?  ....

                                                  So the govt essentially created the current crop of "too big to fail" companies by restricting the marketplace.  What did we do that created them?  What, for example, created giants like AIG and then got them overexposed in risky credit default swaps and all the other bizarre items we now hear so much about.   What morphed an insurance company into a highly leveraged financial mess whose failure might have produced economic mayhem (at least that's what the we were all told)?  I always thought those investments were outside of govt involvement because they were too new and too arcane for the existing regulations.  

                                                    • Re: Financial services regulation
                                                      JerryD
                                                      Seems like your position ignores the secondary effects on other, non-stupid people like the loss of interest and lower rates due to higher payments to cover failures of imprudent banks and decreased property values/difficulty to sell due to stupid people or questionable mortgage brokers/banks causing foreclosures. How about the herd mentality where "sophisticated" banks and investors climbed on derivatives that they didn't understand or bought portfolios of mortgages based on biased ratings.

                                                      Seems like "stupid", unethical, greedy, etc. people/companies can drastically affect the prudent, smart people just so we don't put in place reasonable, well thought out regulations. Again, I am not for regulating everything in life but I want to be protected from the damage caused by others either inadvertently or on purpose.
                                            • Re: Financial services regulation
                                              JerryD
                                              I am not advocating protecting the banks. I think the customers are the ones to worry about whether they be "foolish" or just uneducated. The example shown by the smaller banks you mentioned is indeed what I would call "prudent" and worthy of supporting regulations. I have done a number of mortgages and nobody ever offered me 125% of the price of the home and I would have laughed at them as I ran out the door if they did. I have no desire to be on the end of the whip that allows either stupid, uneducated, greedy, crooked, etc. banks or customers precipitate the near fatal crash that we just experienced.

                                              Just as I am still waiting for the person(s) who through their neglect caused Katina, I am waiting for the ax to fall on those that caused the recent crash. My memory is bad but what happened to those who caused the S&L crash? Some were prosecuted weren't they?
                                                • Re: Financial services regulation
                                                  ldgpangeo
                                                  Sensei2001:  I want to assure beforehand that I am not trying to bait anyone with these probing questions.  We have a election coming in two years where the winning candidate's economic policy will play an important role in our nation's direction.  At the present time, I see three tag lines being repeated endlessly:
                                                     a.  We need new rules to manage better the modern investment world.
                                                     b.  We have enough laws, we need the SEC, FED, and others to do their job and enforce them.
                                                     c.  We need fewer rules because the govt inherently can't and shouldn't try to regulate the marketplace.

                                                  Quite frankly, I'm tired of the sound bytes and want to understand the implications of each -- at least to the point of being a more intelligent voter.  Where does one find analysis of these positions for the non-economist professional -- particularly writings that are more than just propaganda pieces for one side or the other.