How the FCIC can help the regulation debate

By Felix Salmon
July 1, 2010
Barbara Kiviat asked why we're even bothering with the Financial Crisis Inquiry Commission, given that the financial regulatory reform bill has been written and negotiated long before the FCIC has even finished its hearings. Her answer is a good one: reform isn't over yet, and there will be further bills and further iterations of the present bill in the years to come; the FCIC's report can and should inform all of that.


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Yesterday, Barbara Kiviat asked why we’re even bothering with the Financial Crisis Inquiry Commission, given that the financial regulatory reform bill has been written and negotiated long before the FCIC has even finished its hearings. Her answer is a good one: reform isn’t over yet, and there will be further bills and further iterations of the present bill in the years to come; the FCIC’s report can and should inform all of that.

But another answer to Barbara’s question is given by John Taylor today, who has decided to publish a highly contentious and unhelpful criticism of the Dodd-Frank bill in the WSJ. Essentially what he’s doing is politicizing financial regulatory reform, and trying to make it seem as though the entire narrative of financial institutions being largely responsible for the financial crisis is some kind of Democratic blame game. With any luck, the FCIC report should be authoritative and bipartisan enough to put an end to this kind of thing, especially since Taylor makes the connection explicit:

The main problem with the bill is that it is based on a misdiagnosis of the causes of the financial crisis, which is not surprising since the bill was rolled out before the congressionally mandated Financial Crisis Inquiry Commission finished its diagnosis.

OK, John, I’m going to take that as a promise that you’ll stop talking along these lines if and when the FCIC report directly contradicts what you’re saying. For instance, you say that “the New York Fed had the power to stop Citigroup’s questionable lending and trading decisions” in the run-up to the crisis, and therefore doesn’t need any more powers from this bill. But I expect that the FCIC will show convincingly that the Fed did not feel empowered to take such drastic action before the crisis, and in fact was run on the basis that it was best to leave such decisions to the market. The Dodd-Frank bill is necessary in that it gives the Fed the explicit mandate it needs to grow some teeth and to use them. Powers are useless if you have no mandate to use them.

Meanwhile, your own proposed solution to the problem of how to prevent further crises is simply impossible: “reform of the bankruptcy code to allow large complex financial firms to go through a predictable, rules-based Chapter 11 process without financial disruption and without bailouts”. Well yes, that would be lovely, and it would be great if we could all get a pony, too. But there are very good reasons why banks can’t file for Chapter 11 bankruptcy, all of which you know better than I do: basically, banks can’t operate unless their creditors are confident they’re going to be repaid everything they’re owed, in full.

Taylor’s piece, if you look closely, is quite explicitly written in bad faith: he says that it makes no sense to regulate payday lenders, for instance, or to ask people in the derivatives market to put up more collateral, because these players “had nothing to do with the crisis”, and regulating them will “impede economic growth”. In other words, he’s quite explicitly saying that if a certain activity hasn’t caused an economic crisis in the past, then it shouldn’t be actively regulated. Yet at the same time he purports to believe that the Fed and the SEC can and should have actively regulated bank activities which had also caused no economic crises in the past.

The FCIC, if it does its job well, will be just as effective as the famous Pecora Commission — it will show the dangers of deregulatory impulses, and the necessity of forcing the government to take on responsibility for the overall health of the financial system. And once it has done so, with any luck Republicans will turn from John Taylor’s politicized rhetoric, designed to find fault in anything the Democrats agree with, and will instead embark on a good-faith effort to shore up whatever weaknesses remain in the US regulatory architecture.

Well, a man can dream.

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