Reforming US financial regulation in 2010?

Business Times - 06 Jan 2010

Reforming US financial regulation in 2010? Chances are not so great


FEDERAL Reserve chairman Ben Bernanke insists that more effective federal regulation of the financial industry - and not using the central bank's tool of higher interest rates in order to burst potential asset bubbles - is the best defence against future financial crises.

Calling the recent financial crisis the 'worst in modern history', Mr Bernanke said over the weekend that tighter regulation, and not interest rate hikes, could have prevented the sharp downturn.

'Stronger regulation and supervision' of mortgage lenders 'would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates', said Mr Bernanke during an address before the American Economic Association's annual meeting in Atlanta.

Indeed, Mr Bernanke's speech seemed to be an attempt to defend the Fed's low interest-rate policies over the past decade - at a time when Alan Greenspan had been the chairman and Mr Bernanke had served in the governing body of the central bank - against charges that they caused the last housing bubble.

Increasing interest rates would not have prevented the downturn, Mr Bernanke argued. 'Monetary policy is also a blunt tool, and interest rate increases in 2003 or 2004 sufficient to constrain the bubble could have seriously weakened the economy at just the time when the recovery from the previous recession was becoming established,' he said.

Instead, by suggesting that lax regulation had permitted banks to issue a mishmash of exotic mortgages that many households later had not been able to pay, Mr Bernanke was hoping to convince US lawmakers to strengthen the Fed's regulatory and supervisory power.

The use of 'exotic types of mortgages and the associated decline of underwriting standards' could have been curtailed with stronger government regulation, Mr Bernanke said. 'The lesson I take from this experience is not that financial regulation and supervision are ineffective for controlling emerging risks, but that their execution must be better and smarter,' he said.

Notwithstanding Mr Bernanke's comments, the Fed's loose monetary policies earlier this decade will continue to be criticised by economists who believe that that they ended up increasing consumer spending and contributing to the housing bubble, and by extension to the financial meltdown.

But Mr Bernanke's defence of the Fed's policies and, in particular, his argument that taking into consideration the level of unemployment after the dot-com bubble burst the Fed had no choice but to maintain low interest rates, suggests that the central bank will probably continue to maintain a very loose monetary policy in the next year or two.

And that stance could draw a lot of criticism from Wall Street, the Republicans and inflation hawks who would argue that the Fed is helping create the conditions for new bubbles - while being applauded by the Democrats whose main economic and political concerns have to do with the continuing high rate of unemployment. Moreover, one could also challenge Mr Bernanke's assertion that strict regulatory and supervisory policies would have been effective in addressing the explosion of housing prices. It seems to overlook the fact that the 'alternative mortgage products' that he criticised in his speech were created in response to regulatory pressure to expand home ownership.

Or to put if differently, Washington - the White House, Congress, Republicans and Democrats alike - in the name of enlarging the so-called Ownership Society, insisted that government regulators press banks and mortgage lenders to create the kind of mortgages that would help low-income families put the downpayment necessary for purchasing homes. Of course, this proved to be so 'toxic' that it eventually brought about the collapse of the entire housing industry and the ensuing meltdown of the financial system.

In a way, the Obama administration seemed to have continued pursuing a similar approach through its US$75 billion Making Home Affordable programme that was aimed at protecting homeowners from foreclosures - but that, according to critics, has only hampered economic recovery by postponing the day of reckoning for borrowers who cannot afford to keep their homes.

In any case, Mr Bernanke who is expected to be confirmed by the Senate for a second term, is going to find it very difficult to mobilise support in Congress for increasing the regulatory and supervisory power of the Fed.

In fact, some Republican and Democratic lawmakers are not only trying to strip the Fed of its existing regulatory authority, but are also hoping to win support for a bill that would strengthen the Government Accountability Office's power to audit the Fed and open its operations to public scrutiny - a move that is opposed by the central bank and the Obama administration.

The House of Representatives has already approved a major Wall Street reform legislation in December. But like most of other legislative initiatives supported by the Obama administration, the bill which was approved by a 223-to-202 vote did not win even a single Republican vote.

And the legislative process now moves to the Senate, where Senate Banking chairman Chris Dodd, a Democrat from Connecticut (who is running for re-election this year, facing a strong Republican challenger), has admitted that taking into consideration the opposition from Republican and conservative Democrats to the White House's ideas, the chances for getting a reform bill approved this year are not so great.

Pressure on Congress

In particular, the idea of creating a powerful Consumer Financial Protection Agency, which has been promoted by President Barack Obama and the Democrats, is being opposed by a large coalition of Republicans and a few Democrats who enjoy the backing of lobbyists for the financial industry and other businesses. Reforming the financial regulatory system has been seen as a way of preventing another economic crisis. But, ironically, a rising sentiment that economic recovery is underway may lessen the pressure on Congress to take steps to reform the financial system.

Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.


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