Risk Aversion

U.S. financial stability is in doubt. The candidates should tell us what they'd do about it.

YOU KNOW the financial system is in trouble when Washington has to insist that it's not. Last week, President Bush found himself obliged to remind people that their bank deposits were federally insured. After a hearing Tuesday on bailing out mortgage giants Fannie Mae and Freddie Mac, Senate Banking Committee Chairman Christopher J. Dodd (D-Conn.) announced that "the Fannie and Freddie situation is actually a lot better than certainly the fear would have indicated."

Do they protest too much? Certainly, last week's turbulence shows that the financial stability of the United States is in doubt -- and that political leadership can help restore it. At some point, however, government must move beyond reassuring words and episodic bailouts and address the fundamental problem: The financial system has taken on more risk than its capital base will support. In the long run, the United States needs to modernize financial regulation so that unsustainable risks are not only swiftly corrected but prevented. There is no more important economic issue facing the country; financial crises, including a Fannie-Freddie crunch, may occupy the next president's first 100 days.

Barack Obama and John McCain have made plenty of promises about jobs, taxes and the housing market. But on the big picture they've had less to say. In March, Mr. Obama gave a thoughtful speech in which he argued for regulating financial institutions based on their actual function in the economy, not on whether they are labeled investment banks or commercial banks. Equally wisely, he proposed linking government bailouts with tighter government regulation for the recipients. Less convincingly, he called for a commission to warn about broad risks to the financial system. It's unclear whether the panel would have any power, or simply duplicate the many fine reports on systemic risk already produced by think tanks.

Mr. McCain also last addressed financial stability in the early spring, speaking with a stronger free-market accent and in even less detail than did Mr. Obama. He was right to say that "government assistance to the banking system should be based solely on preventing systemic risk that would endanger the entire financial system and the economy." But that does not necessarily rule out very many bailouts, all of which tend to be justified on that basis. He would encourage increased capital in financial institutions "by removing regulatory, accounting and tax impediments to raising capital" and suggested that current "mark to market" accounting rules might be "exacerbating the credit crunch."

Neither candidate has addressed the growing role of the Federal Reserve in financial oversight. Are these prospective presidents comfortable with the Fed as a guarantor against "systemic risk," as some have suggested? Or would that conflict with the Fed's inflation-fighting mission and draw it into political battles? Both campaigns told us these were legitimate questions; neither would answer them. Even on the prospect of a massive taxpayer bailout for Fannie and Freddie, the candidates are reticent. Mr. Obama has said that he might be for it, if it protects taxpayers and does not bail out shareholders and management. Mr. McCain, who has supported reining in government-sponsored enterprises as a senator, says about the same. The voters are entitled to a much more robust debate on the country's financial stability, and sooner rather than later.