Barney Frank’s financial reform shooting at the wrong target
There is little doubt that inadequate regulation contributed to the financial meltdown of 2008. Financial institutions were using government guaranteed funds to purchase ‘innovative’ financial products whose risks were poorly understood. Investment banks were creating these new products with little or no oversight, generating billions in fees for reallocating risk from those who owned it to those who thought they weren’t buying it. Governments around the world were forced to intervene to prevent catastrophic failure of the global financial system. A major revamp of US financial regulation is an appropriate response.
Ideally, the government should review existing regulation, understand where it fell short in the last financial crisis, and develop ways to fill those gaps.
Unfortunately, the US political system does not work that way. The House passed legislation last week that focuses on punishing the banks, inserting Congress into the decision making of the Federal Reserve, and shifting consumer credit regulation from the Fed to a new agency.
The Consumer Financial Protection Agency is Barney Frank’s reaction to the subprime lending crisis. Democrats in the House apparently believe the subprime crisis was a failure of consumer protection. If the new agency is to have the effect of preventing another subprime crisis, it should be charged with restricting lending to consumers who should not borrow. But of course, it is not. The objectives of the agency are to ensure that: consumers have the information they need to make responsible decisions; consumers are protected from abuse, unfairness, and discrimination; markets for consumer financial products operate fairly and efficiently; and traditionally underserved consumers and communities have equal access to responsible financial services.
Barney Frank does not seem to understand that the financial crisis was caused by an explosion of innovative financial products, sold to investors who did not understand the risks, underwritten by insurers who did not understand the risk, and aggressively leveraged by lenders who did not understand the risks. A large number of consumers were caught in this process, consumers who should not have qualified for loans in the first place. But nothing I’ve seen in the house bill addresses the fundamental breakdown in financial regulation prior to the crash, and more consumer protection (as noble as it sounds) will not prevent another financial crisis.
