Senate leaders and the Obama administration patted themselves on the back after cramming through financial reform legislation. They claim the bill will end "too big to fail" and will prevent future financial crises.
Let's examine these claims, beginning with too big to fail. The five largest companies (
No government of any developed country will ever allow its largest banks to collapse, as that would lead to worldwide economic chaos. Any politician who claims otherwise is dangerously ill-informed or worse.
There were a number of major causes of the financial crisis and panic of 2008. Here's how the Senate bill addresses the most important ones.
1. Reckless Growth of Fannie & Freddie. These giant government-sponsored entities (GSEs) pursued two decades of reckless growth with strong encouragement from the Clinton administration and congressional leaders. The Senate bill does not deal with Freddie and Fannie. In fact, even a simple amendment offered by Sen. Corker, R-Tenn., to impose bare minimum credit underwriting standards on Freddie and Fannie was rejected.
2. Weak and Ineffective Regulation. The U.S. suffered through three major financial crises during the past 40 years (1972-74, the 1980s and 2007-09). The regulatory system that brought us these crises is politicized and badly broken, as Sen. Dodd, D-Conn., recognized when he proposed last November to consolidate regulation into a new, independent Financial Institutions Regulatory Authority. The Senate bill does not address the issue.
The Securities and Exchange Commission (SEC) is one of the principal culprits in the financial panic of 2008. It conspired with the Financial Accounting Standards Board (FASB) to implement mark to market accounting despite objections from the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve and the Treasury, which said it was wrongheaded and would lead to severe credit contractions.
Moreover, the SEC impeded creation of adequate loan loss reserves by banks during the boom years, allowed Wall Street firms to reduce significantly their capital cushions and eliminated regulations on abusive practices by short-sellers. The Senate bill is silent on reforms at the SEC and does not mention the critical need to subject FASB's accounting pronouncements to systemic risk review.
The Senate bill makes a mockery of the Systemic Risk Council, which nearly every objective observer believes is an essential reform to monitor developing systemic risks. Instead of creating an independent Systemic Risk Council, the Senate bill entrusts governance and staffing of the Council to the Treasury and the other agencies the Council is supposed to oversee.
3. Inept and Highly Politicized Crisis Resolution. The banking and S&L problems of the 1980s were far more serious and pervasive than anything we faced this time around. Interest rates hit 21.5%, a deep recession ensued with unemployment reaching 11%, the agricultural sector slid into depression, a bubble burst in the energy sector, the real estate industry collapsed, and third-world debt burdens nearly brought down the mega banks. Roughly 3,000 banks and thrifts failed, including many of the largest. Despite these desperate circumstances, public confidence held, panic was averted and our country entered a period of unprecedented prosperity.
The crisis of the 1980s was managed by an independent Fed and FDIC which made maintaining stability their top priority. The crisis of 2008 was handled by a highly politicized Treasury Department that careened from one failure to the next with no coherent strategy. The markets panicked because they could not determine who was going to fail next, how the failure would be handled or whether anyone was in charge.
The highly inflammatory rhetoric used by government leaders to sell the ill-conceived TARP program was the last straw. The economy flat-lined in October 2008 and the Dow Jones average spiraled from 10,800 on Oct. 1 to 6,500 six months later.
The Senate bill not does not fix what caused the panic of 2008 and in fact compounds the problems. The Fed's and FDIC's emergency powers are curtailed and virtually all crisis management authority is institutionalized in Treasury. This all but guarantees that the Fed and FDIC will not be able to contain the next crisis and we will be left with two very bad choices: a massive taxpayer bailout and/or nationalization of financial system.
The Senate bill is a political document intended to assuage a public rightfully angry about the taxpayer bailouts of car companies and Wall Street. Any politician of either party who voted for TARP and votes for the current reform legislation is not sufficiently serious about fixing our government or financial system.
William M. Isaac, chairman of
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