Friday, April 23, 2010

Financial Reform School

Arnold Kling critiques the financial reform package presently wending its way to its inevitable fate. As you might guess, despite its 1,300 page length there's a lot that's missing: What I Think of Financial Reform

1. No exit strategy from government support for subsidized, lenient mortgage credit. No curbs on Freddie and Fannie, whose market share has skyrocketed in the past year and a half. No increase in down payment requirements for FHA, which is in deep doo-doo.

2. No change to the role of credit rating agencies, as far as I know. It seems to me that one thing that everyone, left and right, can agree on is that the regulators outsourced their function to the credit rating agencies, and this worked out badly. As far as I know, the bill does not correct this flaw. Perhaps it tries to, but other provisions have gotten more attention.

3. Nothing to address the issue of "cognitive capture." The regulators will still get their analysis of the financial sector from the CEO's of the largest banks.

For me, the big hole is the complete absence of any reform of Fannie and Freddie. They are simply left in their present ambiguous position: they remain "private" companies (with their attendant high salaries and perks), yet their liabilities are being back stopped by the government to the tune of $400 billion and counting. Maybe the private/public dichotomy helps company executives sleep at night, along with their naive belief that they are providing "affordable housing," but the fact is that these are now government agencies in all but name. The government is running an off-the-books progressive housing policy that continues the basic abuses that led to the financial crisis in the first place, yet everyone who matters seems content to stand around pretending there is nothing wrong.. I don't know, seems like something the congressional Republicans could complain about, but mostly I'm hearing crickets chirping.

Kling is also critical of the very idea of a consumer financial protection agency on the ground that the abuses in the mortgage industry were a net benefit to consumers:

I have to rant about the notion of a consumer financial protection agency. I know that it's axiomatic that poor people are helpless victims. But in the case of these mortgages, that is a really hard sell. The banks did not take from poor people. They gave to poor people. If you were lucky enough to get one of these exotic mortgages when house prices were still going up, then you got to reap a nice profit on your house. If you were not so lucky, you lost...close to nothing. I'm sorry, but if you borrowed up to 100 percent of the value of the house or more, then all you really lost were your moving expenses.

What about predatory lending? As I understand it, the idea of predatory lending is to saddle the borrower with an expensive mortgage so that you can foreclose on the property and sell it at a profit. How many times did that happen? Have you read of a single instance in the past three years where the bank made a profit on a foreclosure?

All too true, but I don't think it's out of bounds to suggest that the government police consumer lending more energetically. For one thing, if you have banks making loans to people whom they know will have a difficult time paying them back, that should be troubling. The folks who were sold exotic mortgages often had no idea what they were getting. Then, when they realized they couldn't make their payments, many went through months of financial and personal travails trying to hold it all together. The social and personal damage this has caused is obvious and not something that can just be brushed off (although I agree that "predatory lending" is one of those amorphous BS evils beloved of hack screenwriters and hustling progressives).

Look, after mortgages, the most complicated loans people enter into are probably the ones they take out to buy cars. Auto loan documents are long and filled with legalese, yet they are also put together in a way that is at least cognizable. And there isn't any great mystery about their contents. When was the last time you heard of wide-spread abuse of auto loans? Why can't you have the same basic level of comprehension for mortgage docs? And, don't even get me started on credit card "agreements" that (1) are incomprehensible (2) written by the lender to favor the lender in all possible situations and (3) which the borrower often doesn't see until after he's entered into them. No, I think there's a lot of legitimate work for a consumer financial protection agency to do without tripping over legitimate areas of the free market.

Of course, being a racist hater, I need to point out that the reform bill does nothing to resolve the "Too Big To Fail" problem. Just ask the Tea Partiers over at ... NPR: Experts say Bills Won't End Too Big To Fail

We at Planet Money did an informal survey of economists and regulatory experts on the left and the right. We couldn't find any who fully endorse the reforms backed by President Obama and Democrats in Congress.

Everyone thinks the reforms just aren't enough to solve the problem.

Take, for example, "too big to fail" -- the idea that if one of the largest banks in the country gets into trouble, the government will save it with taxpayer money.

"A vote for reform is a vote to put a stop to taxpayer-funded bailouts," Obama said in his speech in New York on Thursday.

I cannot find any experts -- of any party -- who are willing to agree with Obama on this one.

"We're not seeing a very forceful step on the too-big-to-fail problem," said Carmen Reinhart, an economist at the University of Maryland. "If there's any doubt that the crisis may be systemic, we will bail out again."

So, if a major bank says, "Hey, save us or the economy will go under," the government's going to save the bank. Full stop.


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