We are in the late innings of financial reform debate. New and sweeping regulation will almost certainly pass before July 4, 2010.
It has been years since the housing/debt/speculation bubble burst. These bubbles had grown epic in size and became significant portions of the US and global economy. Across the period after 2002, we saw debt and speculation drive our economic “recovery” and subsequently drive our economy into a wall. Jobs, earnings, credit flow and economic growth — world wide — were accelerated and shaped by the debt fueled speculative boom. A systemically relevant shadow economy developed around and outside of dated and underfunded regulatory authorities. This was created by very aggressive risk-taking and lack of prudent self or external restraint in the financial sector.
However, this was a national crisis and not limited to activities on Wall Street. Multi-trillion dollar global meltdowns are never the fault of one industry or a few bad apples. That is simply not how economies work. Wall Street is much hated these days. There are certainly very good reasons for anger, but just as certainly, Wall Street has only a small part in this story.
Financial firms grew large and powerful by inserting themselves front and center in a US economy running on debt and speculation. This was a Main Street phenomena every bit as much as a Wall Street phenomena. Home mortgage debt more than doubled between 1995 and 2003 to $6.9trillion dollars. Mortgage debt nearly doubled again to $10.5 trillion between 2004 and 2008. Main Street realtors, appraisers, families, lenders and decision making were front and center in creating crisis conditions. This is not to say that there was not massive and massively dangerous exploitation of the debt and speculative desires of American households by many in the financial sector. What we need to learn is that the financial crisis wasn’t caused by the wickedness of a few people in New York. Our economy had a huge structural flaw that was systematically exploited.
This exploded as highly indebted consumers could neither pay off the money they borrowed, nor borrow more. A labyrinth of structured financial products had been profitably and unwisely built on the excessive debt. Thus, the pain and destruction were amplified and transmitted globally.
President Obama’s address on financial reform makes many strong and reasonable points regarding the need for change and modernization of our financial regulatory system. Many of the innovative tools designed in the financial system offer powerful new economic opportunities. Many of these tools were misused for short term gain. The tools themselves are not the issue. The president has a difficult job as Wall Street firms are historically very generous with the Democratic Party (hedge funds particularly have been disproportionally generous to the president’s party — since 2000 hedge funds gave between 65 percent and 70 percent of their political donations to Democrats). The regulations suggested in the House and Senate bills may fall short of the sharp rhetoric we heard today. We are yet to see significant financial reform, except for firms yet to repay TARP funds. We clearly need reform and we need to rationalize a system with many different regulators that create over-regulation in some areas of the financial space and massively under-regulate other areas.
Our pattern of over a dozen agencies duplicating and intensively regulating some activities and completely ignoring other activities has created adverse incentives and problems. We can’t have large unregulated areas where vast wealth migrates. This creates large and gathering systemic risks that are not understood until crisis strikes. The under-regulated spaces grew as America’s thirst for debt and speculation outgrew traditional channels. Ideologically driven faith in market self regulation, was taken to excess and risks rapidly overtook rewards. We need a systemic regulator to oversee the system as a whole.
Large firm resolution authority is needed to prevent regulators of the moment from making questionable calls during crisis about which firms live and which firms die. We need exchanges to trade products and make clear and complete information available to all market participants. Our firms and financial markets need to rebuild the confidence that has been lost. The IMF report to the G-20, released by the BBC on April 16, 2010, makes clear that all these regulations will be called for in the June 2010 meeting. The strong points made in the President’s Speech mostly echo these sentiments. This is important. If the US ends up with more restrictive regulations than other advanced economies, jobs will be lost and systemic risks will remain.
Financial reform is overdue but it must be done delicately. We must remember that this crisis grew first and foremost out of the imbalance between what middle class jobs pay and what middle class lives cost. No financial reform will fix this problem. Wall Street did not create this crisis alone and financial reform cannot and will not rebalance the US economy. Modernization and rationalization of financial regulation is needed and will help.
This article originally appeared on The Huffington Post.