By Steven Pearlstein
Friday, April 30, 2010; A14
Here's a simple explanation for the financial crisis: Too much cheap credit was extended to households, businesses and even sovereign governments that couldn't afford to carry that debt or pay it back. The obvious implication is that, going forward, credit and other financial risks should be made more expensive and harder to get.
Now, however, as we close in on the endgame for financial regulatory reform legislation, special interests are crawling out of the political woodwork demanding loopholes and exemptions. And if you strip away their end-of-the-world-as-we-know-it rhetoric, their basic complaint is that the reform bill would make credit and other financial risks more expensive and harder to get -- in other words, the bill is doing exactly what it is supposed to.
Let's start with the auto dealers, who are running all over the Capitol this week claiming that the cost of an auto loan will increase if they are subjected to supervision by a new agency charged with preventing fraudulent and abusive consumer lending. Judging from their rhetoric about the nightmare they will face with all that costly and time-consuming paperwork, you'd have no idea these were mostly multimillion-dollar retail giants with multiple franchises in multiple cities. Nor would you know that they act as the front end of a giant auto-loan conveyor belt that stretches back to Wall Street's "shadow" banking system. Nor would it be clear that dealers often earn as big a profit financing a car as they do selling it, and that as the point-of-sale lender, they are not above engaging in high-pressure tactics to get customers to sign loan documents before they leave the showroom and before they have a chance to shop around with other lenders.
The dealers' argument, of course, is a carbon copy of that used years ago by mortgage brokers and lenders who successfully fought attempts to make them abide by the same rules as regulated banks. And over time, those cagey brokers and lenders used their regulatory immunity to earn huge profits and gain a greater share of the mortgage market by offering unsuitable loans to unsuitable borrowers before selling those loans off to Wall Street. An underwriting race to the bottom ensued that eventually led banks to start up or purchase separate mortgage subsidiaries so that they could operate in the unregulated environment. We all know how well that turned out.
If there is one lesson that ought to have been learned from the recent crisis -- as well as the savings-and-loan debacle of the late 1980s -- it is that everyone who engages in the same business should be regulated in the same way by the same entity, irrespective of the charter they hold. If car dealers want to be in the lending business, they should be regulated like every other lender for the simple reason that their customers deserve the same protections as other borrowers.
Small banks are making many of the same arguments as the auto dealers as they seek to insulate themselves from virtually every provision of the financial reform bill. The community bankers are under the wrong impression that the aim of regulatory reform is somehow to punish those who caused the crisis or to ensure that the same crisis doesn't happen again. In fact, the purpose is to anticipate and prevent the next crisis, which is just as likely to be caused by hundreds of community banks simultaneously engaging in the same risky behavior (remember the savings-and-loan crisis) as it is from the mistakes of a few large Wall Street banks.
If the community bankers have their way, however, they'll not only be allowed to keep their present regulator but continue to be able to find another if the present one gets too tough. Their capital requirements and deposit insurance premiums would not reflect the recent rise in failures and losses. They could continue to delay writing off the losses from all those crappy loans they made to local developers, many of whom just happen to be directors. Their shareholders would be denied any say in the pay of top executives or even any additional information about that pay. And they would be exempted from new rules requiring them to keep some of the risk from the loans they sell off to Wall Street. They're also backing a provision to prevent big banks from getting any bigger and taking their customers. Other than that, though, the community bankers are gung-ho for reform.
Any listing of special pleaders would be incomplete if I didn't mention those struggling Main Street companies that use derivative contracts to hedge some of the currency, or interest rate, or commodity risks of their basic businesses -- you know, companies such as Exxon, Southwest Airlines and Caterpillar. Although the reform bill requires that most derivatives be traded on open, regulated exchanges that require buyers to post collateral, the "end user community" wants an exemption from all that. On the face of it, that seems rather curious -- open-regulated exchanges normally lower the prices of the things traded on them by reducing the spread between what is bid and what is asked. But it turns out that because most of these end users have triple-A credit ratings, Wall Street's swap dealers waive any requirement that they post collateral, which not only results in lower costs for the end users but also higher margins for the dealers than if the contracts were traded on an open exchange.
The losers in this arrangement, of course, are you and me. Without the collateral to back up these contracts, the entire financial system is denied the extra cushion that comes in rather handy in preventing financial crises. Think of American International Group, another AAA-rated company that used its giant balance sheet to secretly load up on derivatives, or Enron, the blue-ribbon energy company where the futures and derivatives trading desk became the tail that wound up strangling the dog.
If the price of regulatory reform is that it raises the cost of derivatives trading for end users, it is only because the cost of derivatives trading was too low and never reflected the true cost of the systemic risks and taxpayer bailouts needed to deal with them. Rather than bellyaching about modest increases in costs, these well-heeled end users ought to be thanking us for decades of implicit subsidy of their hedging activity and graciously offering to start paying their fair share.