Obama’s Financial Regulation Overhaul is not Defined

Public Policy Outlook and Trends: Obama’s Financial Regulation Overhaul is not Defined

by Alton E. Drew


President Obama is unveiling an overhaul of the nation’s financial regulatory framework this week.  The goal of the new policy is to make it less likely the economy will hang on the edge of collapse by giving policy makers more tools to control a crisis the next time one occurs. Mr. Obama envisions a less volatile financial market place where banks are encouraged to take fewer risks where leverage, liquidity, and capital requirements will be tougher.  In other words, the government is offering a better way to settle an upset stomach.


While the specifics of the plan have not yet been released, The New York Times reported that broad strokes of Mr. Obama’s plan would include an expansion of the Federal Reserve’s role in managing systemic risks.  Mr. Obama also envisions that the federal government will be able to unwind and break up systemically important companies, especially “non-bank” companies like AIG or the old Lehman Brothers.  The plan, however, does not anticipate any consolidation of power so supervision of the banking system will continue under several agencies.  Nor will there be a merger between the Commodity Futures Trading Commission and the Securities and Exchange Commission.  It should be harder, under the plan, for large companies to be overleveraged.


There are a couple fatal problems with this plan.  In general, as a policy designed to address a slowing economy, a policy based on additional regulations does not meet that task.  One would argue that the Administration and the Democratic Congress have already addressed the issue of contraction in the economy with the passage of the American Recovery and Reinvestment Act and the $787 billion of stimulus funds included in it.  Whether one agrees with the amount of the stimulus or whether there should have been a stimulus package is now a moot point.  The package arguably addresses the components of gross domestic product, namely personal consumption, business investment, government spending, and exports.  If the Administration is interested in a plan that will promote an increase in national income, it would be best to wait and better ascertain the progress of the stimulus plan.


Contrary to popular belief that “green shoots” or “green sprouts” or whatever vegetation you are in to are popping up all over the garden, the economy is not bottoming out.  The contraction in real GDP has increased over the last two quarters and the gap between current dollar and real GDP has increased 75% between first quarter 2009 and fourth quarter 2008.  Specifically, according to the Commerce Department, the decrease in real GDP for first quarter 2009 reflected “negative contributions from exports, equipment and software, private inventory investment, non-residential structures, and residential investment.” Surprisingly there was also a downturn in government spending in first quarter 2009 but in all fairness this cannot be indicative of the effectiveness of the stimulus package since it was enacted in February.


The plan draws no nexus between a policy of bank regulation and stimulating business investment.  Particularly troubling is the policies aversion to risk taking.  A business that needs to invest in equipment and software or private inventory pursuant to a business model that, though risky, may provide high returns to investors,  runs the risk of being turned down under a regulatory scheme that may put the brakes on placing capital at risk.  Risk taking is the cornerstone of investment and growth and limiting it may be fatal to the economic growth Mr. Obama seeks.   


As policy possibly the most fatal flaw is that the Administration has not properly defined the problem that it is trying to solve with this proposed policy.  The problem allegedly started because of defaults on sub-prime mortgages and the failure and collapse in values of financial instruments backed by these very mortgages.  If that was indeed how the problem germinated, why then do we have a proposed policy that promotes intervention into the market against the sellers of financial services especially where we have little if any evidence of traditional market failure?  The rational approach would be a policy that punishes the consumer behavior that started the crisis; one that helps change the mindset of consumers by encouraging more saving and investment.  Also, given the increase in unemployment, now at 9.4% and estimated to hit 10% by year-end, there should be additional focus on job and opportunity creation, activities, ironically, that require some risks.   


Unfortunately, the Obama Administration prefers to pursue the course of attacking the corporate structure versus focusing on the problem.  It is like letting an overweight person off the hook by not telling him to eat right and exercise and instead letting him take more drugs because he is least likely to be offended.  We increase the longevity of illness by adding to the delusion.


Published 15 June 2009

About Alton Drew

Alton Drew brings a straight forward and insightful brand of political market intelligence. Alton Drew graduated from the Florida State University with a Bachelor of Science in economics and political science (1984); a Master of Public Administration (1993); and a Juris Doctor (1999). You can also follow Alton Drew on Twitter @altondrew.
This entry was posted in Economy, Financial Regulation, Political Economy. Bookmark the permalink.

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