Wednesday, March 31, 2010

Heading Off The Next Financial Crisis

With the Health Care Reform Bill now delivered by this Congress, attention will turn to financial regulatory reform. As I mention constantly to the students in both my Securities Regulation and Corporations classes, we stand at an extremely important historical moment in connection with the way our nation does “capitalism.” Whether this Congress will be thoughtful, introspective and historical (meaning embracing the lessons of history and appreciating/comprehending the morass of regulatory action stacked now for more than seventy-five years) in writing, debating and enacting new regulatory legislation remains to be seen. I am hopeful, yet dubious.

To that end, David Leonhardt of the New York Times wrote a thoughtful piece for the Times Sunday Magazine that attempts to address the importance of this moment. Per Leonhardt and the NY Times:

"A public good is something that the free market tends not to provide on its own, to the detriment of society. Pollution laws and police departments are classic examples. In the case of finance — and of the crisis of the past two years — this missing good has been strong regulation. A weak system of regulation allowed Wall Street firms to take on enormous debt. Those debts let the firms make more and riskier investments than they otherwise could have, lifting their profits. But when the value of the investments began falling, the firms had little margin for error. They were like home buyers who made a tiny down payment and soon found themselves underwater.

It was tempting to let the banks fail. They certainly deserved it. But big bank failures often cause terrible damage. Credit dries up, and the economy can enter a vicious cycle of falling asset prices and job losses. That is what began to happen in 2008. To get credit flowing again, the federal government came to the rescue with billions of taxpayer dollars. It was a maddening story line: the government helped the banks get rich by looking the other way during good times and saved them from collapse during bad times. Just as an oil company can profit from pollution, Wall Street profited from weak regulation, at the expense of society.”

To read the rest of the article, click here.


  1. Financial re-regulation should be the next item on the agenda - no ifs, ands or buts about it, boys and girls. We had thirty years of deregulated "Reaganomics" and look where that got us. It is my wish that one day the American people overcome their dysfunctional love affair with Ronald Reagan and wake up to the reality that the Gipper was a complete and utter fool.

    I was starting to get a little depressed about President Obama. I feared he was on the fast track to becoming another Bill Clinton. It now seems that he might want to be another Franklin Roosevelt. He may be FDR Lite, but I'll take what I can get, thank you very much.

    This administration will really get some steam behind it once the midterm elections are behind it. Count on a major upset for "the party of Lincoln" (TOO FUNNY!) in November The months between now and then will only see their continual implosion.

    Tom Degan

  2. It isn't that we as a nation always need to impose new regulations - often answers can be found in adhering to existing regulations that were not properly enforced. Every time there is a crisis, the media amps up the pressure for "reform" and law are passed and rules are promulgated as a knee-jerk reaction that are done in haste and not thoughtful.

    That, coupled with little political will to prosecute against supporters, stymies any self-reform and relegates us to the status-quo until the next implosion occurs.

  3. “So there is a very good argument you should put a tax on finance, like a tax on pollution.”

    Even though I agree that the current system needs to be taken a look at and that vast changes are needed in order to head off a new crisis, I think the above mentioned statement from the article is highly cynical. The financial system is not destined to have panics and upheavals. The idea of taxing something that is not inherently evil because of the threat of a future negative occurrence seems very unfair. Pollution is an inevitable negative result of production and taxes on it are needed to encourage conservation and fund the response to problems that will occur from its existence. Finance, at its core, is necessary for society and if regulated carefully will not harm the average person. A new reactionary tax levied by the government will do nothing but placate the public and lead to more regulation that will be passed along to the average citizen with increased fees and a lack of available lending and credit.

  4. Zshakira CarthensApril 1, 2010 at 11:26 AM

    For me, whether it is appropriate for the government to regulate something depends on what you are suggesting the government should regulate, and to what extent. Before the economic recession, banks were essentially making their own rules. The mortgage crisis called for regulation as banks have shown themelves unable to evaluate a prospective homeowner and give them a realistic mortgage. Undoubtedly banks do not want people to loose their homes, they make much more money when you pay on your mortgage for 30 years.

    However, so many people were not in a position to buy the home they wanted; rather than say no, banks would still say yes because banks don't make money denying people loans to people. They make money giving people loans.

    Regulation will discourage banks from taking the types of risk that they have been taking. Ofcourse regulations are only effective to the extent that they are enforced. In summary, I believe in the regulations included in the new plan. I just hope they are enforced to the full extent.

  5. It is my opinion that the main focus of this congress should be plain and simple to come up with strategies and methodologies that will help create more jobs in mainstream America. This plan will inevitably include some new regulations however, I do agree with the statement above that we need to "adhere to existing regulations that have not been properly enforced."

    Nonetheless, if there are more jobs available for everyday Americans then we will see less of a need for unnecessary regulation. Although this will certainly not happen over night as congress will have to build a solid foundation before executing any new regulations. When the change does start to occur the new jobs will create a trickle down effect that will help keep the free market afloat.

  6. Elizabeth StyonsApril 3, 2010 at 3:14 PM

    I do think new regulation is needed. What we have in place now does not work. After this recent financial crisis, it is so important for banks to be able to stand on their own feet without having the government bail them out for making stupid decisions. Maybe not every single problem can be prevented, but meticulous regulation can prevent the same thing from happening again. It is very key for the regulations to be enforced religiously, even if the market bounces back and everything seems to be going well. I hope Congress can pull together a re-regulation that gets the job done.

  7. I agree with Mr. Cumming's perspective regarding the regulation (lack of regulation?) of banks when the federal government turned a blind eye to the banks when they were getting rich and then are helping them out when they get in hot water. It is tough to legitimize, but as he says, banks are obviously an important link in the economic chain and are necessary for the growth of the rest of the economy. I think this Congress needs to take a look at regulation and try to figure out how we can get promote increased accountability for the banks while also increasing growth (including loans for businesses that will ultimately increase employment and stimulate the entire economy).

  8. I think the decision to regulate big banks walks a fine line. The regulation would have to be balanced such that it would not promote too much control by the government but be comprehensive enough so that banks will be accountable for their actions. I agree with Ms. Styons that it if regulations are put in place, they should be enforced even when things are going well in the financial world. Unfortunately, we don't think about these things until there is a problem. We have a "here and now" way of dealing with these things. Regulation may help in the future but as always I am skeptical.

  9. It is unfortunate that the banks were given a bail-out, and saved from self-termination with taxpayer monies, but Americans were not afforded the same luxury. My biggest problem is the lesson those on Wall Street have learned - nothing. Will they take advantage of a similar situation in the future? Although I do not want the government to have any more control over businesses than the next person, I believe the only way to prevent a similar situation is through government regulation. Perhaps Congress can develop some sort of regulation that does not interfere with the freedoms of trade and capitalism, but instead works to keep Wall Streeters from making such hasty and risky decisions at the detriment of the rest of the country.

    I am interested in the ideas that will come forth, and if these decisions will be favorable to both parties instead of being conflicting like many issues were in the health care bill.

  10. LaKeeshia AustinApril 5, 2010 at 7:19 PM

    There must be regulations in place or some will take advantage and others taken advantage of. What's sad is that this problem was foreseeable by the government years ago, and even warned about it but the "regulators" were overruled by the politicians.

    If the bailout had not happened, the economy would be in a much worse position than it is now. Even with the bailout, a lot of people are still unable to obtain loans and credit because of the weak economy.

    We definitely need to stick to the plan, as Ms. Styons noted, as soon as we figure out what the plan is...

  11. I tend to agree that the solution is not always found in writing new legislation but in enforcing and perfecting that which is already on the books. I also believe now is an excellent time as any to search for creative, out-of-the box approaches. For instance, a portion of the banks repaid debt should be set aside for special lending to innovative companies and educational institutions. The idea is for schools to create curriculum to match the regional jobs needs, effectively growing and creating a local workforce. We need jobs, jobs, jobs. That will be the booster shot our economy needs. Creative solutions is what it will take. And making banks responsible corporate citizens can be a win-win for us all.

  12. One of the points brought up in the New York Times article is to “put a tax on finance.” The idea of a financial transactions tax has been around for quite a while, with several proposals as to how to spend the money. Now, in the U.S., it seems to be discussed as a way to generate revenue to pay back TARP money and bring down the deficit. The concept of a transnational FTT has been kicking around the United Nations for quite a while as a way to raise money to provide financing for developing countries. Recently, the FTT is getting seriously studied by the International Monetary Fund as an international tax, and a way to raise money for an emergency fund to provide assistance. The core idea is to tax at a low rate that is hardly noticeable to the financial flows, but to use it as a redistributive measure to cushion the blow for people who don’t reap the largest benefits in the financial markets but who still suffer its consequences.

    Wikipedia has an interesting article on the FTT, under another name for it – the Tobin tax, named after a Nobel Prize-winning economist who first suggested one version of the concept:

  13. I worked in securities regulation for 13 years. It's a system that needs fixing, but I get a little upset when people overstate the responsibility of regulation to the financial crisis. By definition, stocks are risky, and people should not invest in the stock market unless they are will to accept risk. Also, what regulatory authority allowed banks to market mortgages to people without income verifications? The majority of stock market investment is done by institutions, including hedge funds. Institutional investors are professionals that don't need their hand held about the suitability of their investment. I think the problem comes in where we can't distinguish between the institutional investor and the individual (retail) investor whose money is being put at risk. We still need to protect the individual investor, and that has always been the goal of regulation. I think part of the mistake was in thinking institutional investors in their knowledge were also acting in their in the best interest of the investors.

  14. Drew Sietsma –
    The four largest commercial banks now control 40% of the nation’s $8 trillion in bank deposits. Since the beginning of the recession, these institutions have significantly curtailed lending for small businesses. Frozen credit markets plague small business opportunities. Over the past 15 years, 2/3 of new jobs created in the United States were created by small businesses. Since the beginning of the recession, these firms have had enormous difficulties gaining capital. While large and medium sized businesses have recently begun to show signs of stabilization due to the infusion of massive amounts of tax-payer provided financial aid, small businesses continue to fight for their very survival. Banks are unwilling to provide credit for the very entities which provided the capital necessary to propel their economic recovery. The largest banking institutions, the entities who received bail-outs, have decreased new loans by 35% as of January. Without these loans, small business is withering and many are in danger of collapsing or have already closed their doors for good. There must be greater pressure exerted on the commercial banks to extend credit to small business. Without this lending, the economy will continue to shed jobs and the strains endured by average Americans will continue to increase.

  15. I have a problem though with those market makers of the NASDAQ, most likely working for the investment banks who on the otherside loan money to corporations. Lines need to be drawn and the fact that these banks can par take in so many aspects of the securities market is fishy at best. Stocks are risky, but how risky should be a 401k? Institutional investors are well learned, but whose interest are they best serving?