Regulating Financial Products

Let's start with the agreement that the financial crisis, sated by trillions in government money, has eased. Those who understand LIBOR rates and TED spreads can explain that interbank lending and credit availability has increased. And banks have been able to raise capital, or at least most of them. GMAC wasn't so lucky, and so they're getting a $7.5 billion dollar bailout. And some top banks want to repay the government all of the TARP money.

But claiming that the system is healthy doesn't really pass the smell test. First of all, the program to buy toxic assets hasn't yet been implemented - Tim Geithner now says that will be ready around July. And Geithner's sloth in dealing with the multiplicity of issues has caused something of a crisis of confidence. Ultimately, the banks have been propped up, but the economy remains sick, CONSUMER lending doesn't seem to have bounced back, unemployment keeps rising, and some huge pitfalls, like a second foreclosure wave, remain out there.

We've lost this debate inside the White House - they will do whatever it takes to keep the banks afloat. However, the debate has shifted into what happens afterwards. How will the financial business be regulated to ensure no repeats of this crisis, and to reduce banks to their nominal function of helping capital flow? The White House is talking about moving regulatory power from the SEC to the Federal Reserve, which has a rearranging the deck chairs quality to it. The Fed missed the crisis, too, and are arguably even cozier with the big banks. However, this development would be truly welcome.

The Obama administration is actively discussing the creation of a regulatory commission that would have broad authority to protect consumers who use financial products as varied as mortgages, credit cards and mutual funds, according to several sources familiar with the matter.

The proposed commission would be one of the administration's most significant steps yet to overhaul the financial regulatory system. It would also be one of its first proposals to address causes of the financial crisis such as predatory mortgage lending.

Plans for a new body remain fluid, but it could be granted broad powers to make sure the terms and marketing of a wide range of loans and other financial products are in the interests of ordinary consumers, sources said.

Elizabeth Warren details this plan here - essentially, her argument is that toasters are regulated so that they won't explode in your house, so why not regulate mortgages that can explode with far more fury?

,"It is impossible to buy a toaster that has a one-in-five chance of bursting into flames and burning down your house. But it is possible to refinance an existing home with a mortgage that has the same one-in-five chance of putting the family out on the street," Warren wrote. "Why are consumers safe when they purchase tangible consumer products with cash, but when they sign up for routine financial products like mortgages and credit cards they are left at the mercy of their creditors?"

Warren proposed creating a new commission modeled on the Consumer Product Safety Commission, which protects buyers of products such as bicycles and baby cribs.

A Financial Products Safety Commission would have the power to protect consumers from shoddy financial instruments. For all the power of the banksters, they still had to go to people to get the mortgage-backed securities they needed to feed the beast of the surge of capital during the housing bubble. If the people were protected through regulations that barred the kinds of mortgages they were giving out, we have no crisis.

Simon Johnson has further thoughts coming out of a Congressional hearing on the subject, and he sounds positively giddy.

1. We need layers of protection against financial excess. Think about the financial system as a nuclear power plant, in which you need independent, redundant back-up systems - so if one “super-regulator” fails we don’t incur another 20-40 percentage points in government debt through direct and indirect bailouts. A consumer financial products protection agency should definitely be part of the package.

2. Congress will work on this. The intensity of feeling with regard to the need to re-regulate is striking, and there is much that resonates across the political spectrum.

3. In the end, much of banking is likely to become boring again. Special interests are convinced that they can fend off the regulatory challenge, but I find this increasingly unlikely. Enough people have seen through what they did, how they did it, and what they keep on doing. No doubt the outcomes will be messy and less than optimal, but at this point “less than optimal” is much preferable to “systemic meltdown”.

There is still much to argue about and, no doubt, there will be setbacks. We’ll get a better or a worse system, depending on how the debate goes. And if the external scrutiny slips away, so will point #3 above. But this was still by far the most encouraging hearing I’ve so far attended.

I'm not thrilled with the Administration's policies on the banks so far, but this would really be a step forward and Congress can lead it.