Barack Obama has campaigned hard for the Consumer Financial Protection Act, a series of reforms that he wants to use to launch an entirely new independent agency that will act as a watchdog on financial products. Obama wants to have closer supervision on some of the more arcane but controversial practices in the market, such as default credit swaps that helped accelerate the financial damage from the collapse of the housing bubble. The House has passed almost entirely want Obama wants, but the Senate almost certainly will leave the supervision in the hands of existing agencies rather than expanding the bureaucracy and creating duplication and overlap. AOL Politics Daily columnist Joann Weiner reports that Obama has threatened a veto already, which would be the first substantive veto of his presidency:
Speaking in an online forum immediately following the president’s address, American Enterprise Institute fellow and member of the Financial Crisis Inquiry Commission Peter Wallison predicted that Obama will issue his first veto over the consumer protection measure. Although the House bill creates an independent consumer agency, Wallison said that “there is no chance in the world” the Senate will agree on the same provisions for the CFPA.
In light of this basic disagreement, Wallison noted that “the president said that if the financial reform bill reaches his desk and it does not have real reform, that he will send it back,” adding, “This is the first time that the president said that he might veto a bill that doesn’t have what he has proposed.”
Senate Banking Committee Chairman Christopher Dodd of Connecticut, who has announced that he is not seeking reelection, seems to validate Wallison’s views. Dodd has indicated lukewarm support for an independent CFPA.
There are actually two questions at issue. First, why can’t existing agencies be tasked with whatever additional regulation is required? After all, Obama himself talked about waste and duplication in government, both last night and repeatedly over the last three years on the national stage. Creating a separate agency to handle financial products like credit default swaps and other less arcane and more commercial products when the SEC already oversees these markets is a recipe for both contradictory overlap and holes in oversight. It’s less efficient and builds bureaucratic barriers where streamlined communications would produce better results.
The second question is whether the proposed regulations, even if completely effective and not overly burdensome, would have prevented the collapse in 2008. In order to answer that, one has to understand the root of the failure, which Weiner clearly does not. This is her opening paragraph:
President Obama knows that most Americans have no idea how their local bank transforms thousands of monthly mortgage payments into arcane credit default swaps with AIG. But the president recognizes that the banks’ financial engineering nearly brought on another Great Depression when the house of cards that their structured financial products created collapsed in 2008. And the president is committed to making sure that the American consumer will never again be put at the mercy of the bankers.
The problem with this statement is that is assumes that the AIG portion of the collapse happened in a vacuum. It didn’t. The collapse in the derivatives market — which was apparently a Wild, Wild West — only occurred after the collapse of the mortgage-backed securities on which those derivatives were based. That collapse came from a sudden decline in housing valuations that left speculators in the home market badly overextended and without the equity to refinance — and that came from a bubble created mostly by Congressional mandates to Fannie Mae and Freddie Mac to buy subprime loans in massive quantities and create MBSs with implied government backing to spread the risk. The derivatives, after all, were “derived” from those MBSs with rock-solid credentials, thanks to the Fannie and Freddie imprimatur.
When the housing bubble that Congress created by artificially increasing demand, which in turn artificially increased prices and valuations, finally collapsed under its own weight, that is when the derivatives market collapsed. Better oversight over derivatives may or may not be a fruitful policy path to tread, but all that does is regulate an accelerator to the collapse rather than avoid the next one. Congress needs to stop mandating social engineering by manipulating lending markets for their own desired and artificial outcomes.
Maybe Congress and Obama should concentrate on the next bubble, already in motion at FHA, before worrying about regulating the secondary causes of failure.