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Pretty much everyone agrees on the causes for the country’s desperate financial mess: predatory lenders, weak regulations, even weaker regulators, and risky nigh unto incomprehensible financial instruments.
Congress’s willingness to address those problems will have its first real test on Wednesday when the House Financial Services Committee puts finishing touches on what could be essential reform legislation — or a major disappointment, depending on what they do.
At the top of the committee’s agenda is regulation of the largely unregulated and dangerously opaque multitrillion-dollar derivatives’ market. Next on the agenda is the creation of a new Consumer Financial Protection Agency to oversee the consumer-credit offerings of banks and other financial firms — including mortgages, credit cards, overdraft “protection” and payday loans.
Both reforms are crucial, and we fear both are in danger of being irreparably weakened.
Derivatives are supposed to help investors and businesses manage risk, but their unchecked and unregulated use led — directly and indirectly — to the financial crash and subsequent trillions of dollars in taxpayer interventions.
Congress should require that all derivatives’ dealers and users — including banks, hedge funds and corporations — conduct their trades on exchanges where they would be subject to considerable regulation and public scrutiny. Regulators could create exceptions for customized contracts that are negotiated one on one for truly complex and unique circumstances. But most derivatives contracts are highly standardized and can be, and should be, exchange-traded.
Unfortunately, the proposed legislation has too many loopholes and exemptions. For example, many corporations and hedge funds would still be able to trade standardized derivatives privately. That may protect bank profits — without transparency, there is no chance for comparison shopping — but it would put taxpayers at risk of a repeat calamity.
Like the banks, some corporate investors in derivatives resist exchange trading. They argue that more regulation would raise their transaction costs to hedge any given risk. That’s debatable because greater transparency is likely to reduce costs. But even if true, somewhat higher costs would be a small price to pay for systemwide stability.
The threats to the consumer protection agency are even more blatant. To curry favor with the banks, several lawmakers are intent on amending the proposed legislation so that no state could impose its own — tougher — consumer protection laws on banks.
That would be a mistake because in the past, many states have demonstrated the will and the expertise to protect consumers. But federal rules were issued in 2004 that basically barred states from enforcing their laws over national banks and their subsidiaries. That short-circuited state efforts to control, among other things, the subprime lending that sparked the financial crisis.
Some lawmakers are also intent on weakening the proposed power of the new agency to examine the books of the banks and firms that it would regulate. Current bank regulators have that power, but they have not used it with a sole focus on protecting the best interests of consumers. Routine inspection of an institution’s books is essential to understanding the institution’s products and practices. Without such knowledge, consumer protection would be compromised.
Time and again over the last year we have heard lawmakers vow to protect the American public. We suspect most of them even meant it. But the lobbying power — and contributions — of the banks and the rest of the financial industry can be hard to resist.
The House Financial Services Committee and all of Congress must resist and deliver robust reform. That is the only way to protect consumers and taxpayers, and the entire financial system, from another disaster.