One venerable axiom of American democracy is that we are a nation of laws, not men.
That principle will suffer significant damage, though, if Congress passes the kind of financial regulation measures approved by the House and the Senate.
They are not really about establishing clear rules that create sound incentives. They are about ceding to the federal government more authority to do allegedly good things, like protect consumers and avert destabilizing economic shocks.
They assume the people at the Treasury Department and the Federal Reserve, who missed the warning signals of the last financial crisis, will somehow detect the next one in advance if they have greater power. We wouldn’t bet the farm on it.
One of the ballyhooed changes in the Senate version creates a big new consumer protection agency, which will be empowered to dictate acceptable practices to all manner of companies that provide credit. This is a reflection of Rahm Emanuel’s rule: Never let a serious crisis go to waste.
AIG and Lehman didn’t go bust because consumers were misled about the terms of their auto loans. But given the current unpopularity of the financial industry, Congress can’t resist the chance to impose rules it couldn’t pass before — no matter how far removed they are from the actual problems that it is supposed to address.
One of the best ideas we’ve heard is to require financial firms to accept extra limits on lending once they attain a size that makes their failure dangerous. By impeding companies from growing “too big to fail,” that approach would reduce the chance of future bailouts.
The idea found some support in the House version, which puts stricter limits on leverage as companies get bigger. But the Senate bill has looser limits. And both leave capital requirements, which serve to reduce risk, largely up to regulators. Result: uncertainty that undermines economic health.
Former Fed chairman Paul Volcker made a sensible proposal to bar financial institutions from speculative investments of the sort that helped bring on the crisis.
But the legislation, while paying lip service to the idea, leaves it mostly up to regulators to decide. Maybe they’ll do what Volcker proposes. Or maybe they’ll let the people they oversee talk them out of it once the heat is off.
There are some encouraging signs. Although the House approved a $150 billion fund to pay for liquidating insolvent firms, which would hold out the prospect of more rescues in the future, the Senate rejected the idea, and the administration is also opposed. The Senate bill mandates that big companies prepare “living wills” to facilitate their shutdown if they implode.
But the legislation rests largely on fond hopes that the next time a dangerous speculative frenzy threatens to take hold, people in government will detect the hazards and act promptly to defuse them.
A better approach is to alter incentives and expand safety margins in the industry. Congress can’t make humans less fallible, but it might create buffers to cushion the impact of their mistakes.