More Reasons To Expect The Financial Reform Legislation To Fail

A few days ago we went into detail about how the new financial markets reform legislation that the Senate recently passed (their version must now by merged with the House of Representatives version) is likely to be ineffective for the simple reason that it did nothing to reform or keep in check two of the biggest causes of the economic meltdown: irrational and risky behavior by Fannie Mae and Freddie Mac. We calculated that these two Federal agencies were costing the American taxpayer about $7 billion a month to keep them solvent and that the proposed legislation did not nothing to get them in line from a lending, accounting, and solvency perspective.

If Fannie and Freddie were not enough to doom the effectiveness of the reform legislation, consider an Associated Press (AP) article by Daniel Wagner that appeared on May 24, 2010, titled, "New Financial Rules Might Not Prevent Next Crisis." Mr. Wagner takes a detailed look at the many components that the proposed law covers and provides some in-depth analysis of why the bill may fail in each area:

• Derivatives - many believe that these types of financial products not only helped to pump up the housing market but also magnified the chaos of the bursting housing bubble. Apparently, business lobbying groups got the new rules on visibility for derivative trading diluted so that only the big banks are affected. The old, dangerous ways of doing business for most companies will continue with no new visibility rules.
• Weak banking oversight - prior to the crash, many government oversight organizations failed to foresee the coming financial meltdown and the risky behavior that was causing the crisis and allowed some industry companies to avoid oversight altogether. While this legislation supposedly tightens regulation oversight, there are two problems. Banking lobbyists got serious concessions and a diluting of oversight regulation and many government agencies involved in oversight also lobbied the government (figure that one out, government agencies lobbying government politicians) to protect their turf, resulting in virtually no changes to the government's regulatory hierarchy, a hierarchy that failed miserably in foreseeing the latest recession clouds and storm.
• Too Big To Fail - according to Mr. Wagner, the bill does very little to prevent big banks from getting bigger, implying that taxpayers may still have to pay up for risky and ill timed behavior of the biggest banks in the future.
• Consumer Protection - a lot of the foreclosure and housing problems were caused when consumers took on mortgages and financing plans that they were not qualified for. This part of the bill is supposed to oversee banking products and financing plans and ban those products and offers that are thought to be too risky. However, the oversight in this bill would only extend to lending organizations with over $10 billion in assets. Smaller banks and more importantly, nonbanks, would not be be covered. Since many of the bad mortgages in the past were written by smaller mortgage brokers who sold the mortgages immediately after closing, regardless of how poor a credit risk the deal was, a root cause of the housing collapse, shady mortgage dealers, will not be addressed by this bill.
• Credit Rating Agencies - credit rating agencies such as Moody's and Standard and Poor's failed miserably to detect bad mortgage securities and wrongly gave many of them high credit worthiness ratings. Obviously, most of these high rated securities,s backed by poorly performing mortgages, were disasters so this part of the bill tries to end the practice of banks choosing the credit agencies that rate their investment offerings. An independent board would assign rating agencies. However, the banks still would have to pay the credit rating agencies that are chosen to rate their investments so the incentive to overrate is still present.

Many would say this is a nice try but that is about all it is, a nice try. Many of the problems have not been addressed or they have been addressed in a haphazard or diluted way. The further concern is the House and Senate bills still have to be merged, probably resulting in more compromises and a further weakening of the legislation's intentions. At some point you have to ask: when does so much dilution and compromising result in a toothless bill? The political class will no doubt congratulate itself when the final law is passed but banks will still be too big to fail, underhanded small mortgage brokers and smaller banks will still be pushing bad financing products (which eventually get dumped on the taxpayer via Fannie Mae and Freddie Mac), the regulation hierarchy that failed so miserably a few years ago will still be in place, unseen derivative trading may still stalk the underbelly of the economy, and rating agencies will still be rating, and being paid by banks, to rate a banks investment offerings with the incentive to give a higher rating, while somewhat muted, still present.

Why are we stuck with such ineffective legislation? Possibly two reasons. First, as we have mentioned many times, the political class as an entity is not very smart when it comes to solving large, complex problems. In fact, I cannot even remember the last time they solved a major problem or resolved a major issue. Second, they may not have had a chance in this area since, according to the article, the following organizations lined up for input to the writing of the bill: U.S. Chamber of Commerce, Business Roundtable, Independent Community Bankers, the American Bankers Association, Federal regulatory agencies such as the FDIC, Goldman Sachs and other large banks, the payday lending industry, and the National Automobile Dealers Association.

Mr. Wagner reports that the financial services industry has donated about $2.3 billion to political candidates for Federal public office in the past twenty years. It has also spent $3.8 billion in pure lobbying expense since 1998, more than any other sector. Thus, is it any wonder that possibly the political class is looking out for their own interests and the interests of their re-election funders than the American taxpayer?

This is just another example where Step 39, term limits, as outlined in "Love My Country, Loathe My Government" would be needed. Most people, especially politicians, cannot be expected to act rationally and in the best interests of average Americans and the country as a whole when the banking or other industry is throwing billions of dollars in campaign funding at them. The only real solution is to make sure that re-election is not an option. Then, and only then, can we begin to take money out of the equation and maybe put the country's welfare back into the equation. While we are at it, lets also impose Step 6 which only allow individual citizens to contribute to any campaign and thus, take corporate, union, and PAC money totally out of the election process.

In conclusion, please remember our advice from yesterday's post as this so-called reform legislation moves forward - focus on what the unintended consequences are of the final law, not the intended aims of the law. The intended goals are highly unlikely to be attained, based on the discussion above, while the unintended consequences of such a large piece of legislation could be extensive.

Our new book, "Love My Country, Loathe My Government - Fifty First Steps To Restoring Our Freedom And Destroying The American Political Class" is now available at www.loathemygovernment.com. It is also available online at Amazon and Barnes and Noble. Please pass our message of freedom onward. Let your friends and family know about our websites and blogs, ask your library to carry the book, and respect freedom for both yourselves and others everyday.