By Simon Johnson and James Kwak
Tuesday, September 29, 2009 12:12 AM
The next couple of months will be crucial in determining the shape of the financial system for decades to come. And so far, the signs are not encouraging.
The Obama administration is trying to refocus our attention on regulation, beginning with the president's speech in New York two weeks ago. The financial system, after all, brought us a near-catastrophic crisis that turned a mild recession into a painfully severe one. And Barney Frank, chairman of the House Financial Services Committee, says that he still plans to pass a regulatory reform bill before the end of the year.
But in a clear indication of trouble ahead, Frank signaled his intention last week to scale back the proposed Consumer Financial Protection Agency, one of the pillars of the administration's reform proposals. This new version of the CFPA would exempt many businesses that are not ordinarily thought of as financial institutions but that may offer some type of financial service to customers, such as telecommunications and other utility companies, law offices and real estate brokerages. In addition, it would not be able to require financial institutions to offer "plain vanilla" versions of certain products, such as a 30-year, fixed-rate mortgage.
Frank may have made these changes because he thinks they would improve the CFPA or because he thinks they improve its chances of passage. In any case, it is another reminder that in Washington -- under this administration, at least -- legislation is shaped not by the White House but by Congress. But does it have to be this way? Just because legislation has to be passed by Congress doesn't mean that the White House can't play a major role in writing that legislation; just see the last administration.
With health care, the Obama administration chose not to offer its own proposal and instead let Congress work out the details, resulting in a multiple-month delay as the Senate Finance Committee negotiated a bill that has the support of neither side. With financial regulation, by contrast, President Obama unveiled the administration's reform proposals June 17, and the Treasury Department backed them up with draft legislation it sent to Congress. On June 18, describing the CFPA, Treasury Secretary Timothy Geithner said, "This agency will be able to write rules that promote transparency, simplicity and fairness, including defining standards for 'plain vanilla' products that have straightforward pricing." In addition, the draft legislation included a very broad definition of financial services that would be subject to the agency's authority -- essentially, anything the agency called a financial service, with the exception of insurance.
We have criticized the administration's reform proposals, in particular for not going far enough to address the problem of financial institutions that are "too big to fail." But we support much of what was in the original package, particularly the CFPA and increased regulation of complex financial products. The question now is how hard Obama and Geithner will fight for it.
Financial regulation, like health care reform, has entered the phase where speeches and proposals matter less than arm-twisting and horse-trading on Capitol Hill. With health care, President Obama attempted to go over the heads of Congress, directly to the American people. With financial regulation, that is no longer an option, given the extent to which it has faded from public consciousness.
Instead, the administration is playing on the home turf of the banking industry and its lobbyists. Even back in April, the industry was able to kill Obama's request for legislation allowing bankruptcy judges to modify mortgages. Five months of profits later, the big banks are only stronger. Is Obama up for this fight?
And it's not only consumer protection that the banks are gunning for. As Satyajit Das described last week, the International Swaps and Derivatives Association is getting ready to fight off derivatives regulation once again, after successful campaigns in 1994, 1998 and 2000. This time, their strategy is to exempt as many derivatives as possible from centralized clearing, thereby keeping them out of sight.
There will also be a major battle over bank capital requirements, particularly the administration's proposal to increase requirements for the largest financial institutions. On this issue, the administration's rhetoric is in the right place, but everything will come down to the details -- in this case, how much more capital is enough? This is precisely the kind of issue that the industry wants to leave to a congressional subcommittee -- or, even better, a regulatory agency -- where it can flex its muscle quietly.
During the reign of Louis XIV, when the common people complained of some oppressive government policy, they would say, "If only the king knew . . . ." Occasionally people will make similar statements about Barack Obama, blaming the policies they don't like on his lieutenants.
But Barack Obama, like Louis XIV before him, knows exactly what is going on. Now is the time for him to show what his priorities are and how hard he is willing to fight for them. Elections have consequences, people used to say. This election brought in a popular Democratic president with reasonably large majorities in both houses of Congress. The financial crisis exposed the worst side of the financial services industry to the bright light of day. If we cannot get meaningful financial regulatory reform this year, we can't blame it all on the banking lobby.