If you haven’t been completely obvious to the financial news this week (or to news in general), then you’re likely aware that on Wednesday, President Obama made an announcement about some rather sweeping changes to the nation’s financial system. If you feel like reading up on the full list of proposals, you can read the government’s (88-page!) white paper on the subject, assuming you have the time and willingness. If not, read on, for I shall give you a thumbnail sketch of some of the biggest points. (With assistance from BusinessWeek)
First Proposal: Creating a Consumer Financial Protection Agency, in charge of regulating consumer financial products (credit cards, mortgages, bank accounts, etc.) with the goal of standardizing the products offered and increasing disclosure to consumers.
Pro: More disclosure from financial firms; easier comparison of financial products from diverse companies due to government standards; and an overall safer financial system.
Con: Stifled creativity on the part of financial firms when creating new products; and more difficulty for individual firms to make their products stand out.
My Take: In theory, I like the idea of a broader, overarching agency monitoring financial markets the same way that the FDA and other agencies monitor our food supplies. In practice, I’m sure it’s going to take quite a bit of fine-tuning to adequately protect financial product consumers while allowing banks and other agencies to make a decent profit. Given the current state of the economy and the regulatory system, I think it might be best to opt for regulation, even at the risk of over-regulation, and back off from there.
Second Proposal: Require that banks and mortgage companies that originate mortgages and other loans keep at least 5% of the assets should they securitize the loan (they’d have to ‘keep some skin in the game’).
Pro: Lenders are less likely to push risky loans when they could face financial consequences if the loan defaults; and it puts a de facto cap on the amount of leverage lenders can utilize (at twenty times the organization’s lending capital).
Con: Won’t neccessarily prevent excessive risk taking by lenders.
My Take: This proposal should do well in decreasing the number of lenders who take on great amounts of excess risk; suddenly, giving mortgages to dozens of subprime borrowers starts to seem like a bad idea if their defaults will have a direct negative influence on your bottom line. The percent the originators are required to keep seems a bit low to me, but I suppose limiting their ability to sell loans and lend again too much would result in far fewer loans being issued, even to qualified applicants. Five percent (and the twenty times leverage it potentially offers) seems like a good compromise.
Third Proposal: Appointing the Fed (that is, the Federal Reserve) to regulate systemic risk in the financial markets, backed by a council of other regulators chaired by the Treasury,.
Pro: Provides increased power to regulate the economy as a whole; allows the Fed to take the lead in decreasing systemic risks posed by events in the financial markets
Con: The Fed could end up being too powerful; worries that the Fed will fail to provide adequate oversight.
My Take: While it seems like a good idea to assign one organization to take point in providing regulation to the market, there are legitimate concerns about leaving that job in the hands of the Fed, especially as there is no direct Congressional oversight. The key will be finding a compromise that minimizes the number of worried parties; the Obama proposal, for example, attempts to add more oversight to the Fed by giving some oversight of their actions to the Treasury.
Fourth Proposal: Adding increased oversight and funding requirements for derivatives trading.
Pro: Decrease the risk level in a fairly risky financial sector; add disclosure and standardization to credit default swaps and other complex derivatives.
Con: Push back from derivatives traders who are used to an environment of secrecy; difficulty in regulating the sometimes highly individualized trades.
My Take: This one is a tricky one, but necessary if we’re going to avoid a repeat of the last year. Getting derivatives trades out into the open, ensuring that the traders have enough capital to back their trades, and understanding the level of risk involved is the only way to allow this trades to continue while preventing future financial collapses.
All of these proposals, of course, still need to be debated and approved; for the most part, though, I think they are a definite step in the right direction, and a good way to push the financial system back on track.