The election and the economy

Business Times - 02 Apr 2008

Democrats have upper hand in presidential race

Their approach resonates with call from homeowners, consumers for more govt action


IT WAS not so long ago that officials and lawmakers in Washington were joining investors on Wall Street in a warning that the United States was losing its edge in global financial markets.

The culprit, they complained, was the US federal government that was placing burdensome regulations, most notably the Sarbanes-Oxley legislation passed by Congress in 2002 in the wake of the Enron and other financial scandals. The critics concluded that government intervention in the financial markets was driving business away from New York, and strengthening other financial centres around the world such as London and Hong Kong.

Indeed, exactly a year ago, US Treasury Secretary Henry Paulson and Securities and Exchange Commission (SEC) head Chris Cox brought together a group of leading economic figures from Wall Street and Washington - including former Treasury secretary Robert Rubin, and former Fed chief Alan Greenspan - for a meeting at Georgetown University, where almost all the speakers bashed the government regulations that were allegedly hindering the competitiveness of American capital markets.

Mr Paulson and the Republican and Democratic lawmakers who took part in the meeting promised to take steps to reform America's regulatory regime - they would ensure that the government cease harassing those besieged investment banks - and make the financial markets more competitive.

What a difference a year of growing financial crisis makes! None of the participants in the Georgetown University conference last March is focusing these days on how to loosen the federal government's regulation of the financial markets so as to allow the growth in ever more sophisticated derivative instruments and the blooming of new hedge funds.

Mr Paulson, the former investor who was brought to Washington to help reassure his ex-colleagues on Wall Street of the Bush administration's commitment to continuing deregulating the financial markets, is now leading the way in altering the pro-free market policies that have guided US administrations and Congress since the election of President Ronald Reagan in 1980.

Reagan and his advisers, fans of the economic teachings of Adam Smith and Milton Friedman, helped set in motion a series of dramatic steps aimed at relaxing the influence of the federal government over the American economy, including by embracing an approach of more limited regulation of financial markets.

But that approach seems to be now under attack. Now, everyone seems agreed that there is a need to streamline the regulatory system and strengthen federal oversight of investment banks and the esoteric instruments they sell.

Hence, in the wake of the mortgage market crisis and the growing mess in the financial markets, culminating in the recent collapse of Wall Street giant Bear Stearns, Mr Paulson and his colleagues have drawn the outline of new policies that will lead to the strengthening of federal oversight of investment banks and other sectors of the financial markets - banks, securities firms, insurance companies, commodity investors and mortgage firms - by merging several regulatory agencies and strengthening their authority in dealing with financial institutions and overseeing business practices.

On Monday, he revealed sweeping plans for enhancing the powers of the US Federal Reserve Bank, creating a financial regulator and an agency for consumer protection and business practices.

In a way, the new policy will lead to the restructuring of the relationship between Washington and Wall Street. More specifically, it will provide the Federal Reserve with more authority to investigate troubled financial institutions and take action when the entire financial system is facing major risks. If the new regulatory measures are approved by Congress, the Fed could be empowered to take charge of the responses to future Bear Stearns-like crises on Wall Street. What was perceived to be an extraordinary and temporary action on the part of the US central bank in response to a financial emergency could become, from now on, one of the Fed's standard operating procedures, part of a policy aimed at providing stability to the financial system.

There is little doubt that the new proposals in some form or other - and, in particular, the plan to subject investment banks to some of the oversight that applies now to commercial banks - will be approved by Congress this year.

Indeed, the debate taking place in Washington these days is not about whether the regulatory power of the government in the economy should grow - but on the extent of the possible repercussions of such a process.

Some lawmakers, including congressional Democrats and the two leading Democratic presidential candidates, are demanding that Washington condition any possible assistance to Wall Street on even tougher federal regulatory measures and that it step up its support for other sectors of the economy.

At the same time, many Republicans are cautioning that growing government intervention in the economy in the form of bailouts of failing financial institutions and assistance to hard-pressed homeowners and the expansion of federal regulatory power could end up harming the long-term growth of the US economy.

The Democrats, led by House Financial Services Committee chairman Barney Frank of Massachusetts and Senate Banking Committee chairman Christopher J Dodd of Connecticut, insist that a financial system that privatises profits - the kind that investment bankers have been making in recent years - should ensure that losses are not being socialised - in the form of huge federal-backed bailouts of failed investment banks.

That requires the state and federal government agencies to retain the power to closely scrutinise investment banks, hedge funds, private-equity firms, and various players in the mortgage industry.

The Republicans prefer that the oversight be handled through self-regulation, by a more voluntary system dominated by the private industry and not by government agencies. They also assert that the government should come to the assistance of struggling financial institutions only in extraordinary circumstances so as not to provide them with incentives - the so-called 'moral hazard' - to act irresponsibly again in the future by taking new risks.

At the same time, the Democrats, including presidential candidates Barack Obama and Hillary Clinton, are arguing that a federal government that goes out of its way to assist Wall Street should also take steps to help Main Street.

They both unveiled new plans that call for government-funded assistance for struggling homeowners that could cost more than US$30 billion. Among other things, the government would underwrite federal loan guarantees to help refinance mortgages for homeowners who are at risk of defaulting.

The Bush administration and Republican presidential candidate John McCain have been opposed to the idea that Washington should come to the rescue of homeowners who have lost money or even went bankrupt. In a major economic address last week, Mr McCain argued that 'it is not the duty of government to bail out and reward those who act irresponsibly'.

The contrasting points of view of the Democrats and the Republicans on the role of the government in the economy are bound to become a central issue in the election campaign. At a time when struggling homeowners and consumers are demanding more action on the part of Washington, the Democrats could have the upper hand in this debate.

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


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