Meltdown Insurance

Posted July 13, 2010, at 6:55 p.m.

Nearly two years after the U.S. economy risked historic meltdown, Congress has agreed on a plan to put barriers between investment institutions and the abyss. The plan that emerged after negotiations might have been stricter regarding the exotic investment instruments that banks have invented, but refreshingly, it puts the consumer into the equation. Its provisions are tailored to the specifics of the recent crisis, as they should be, but its empowerment of regulatory agencies may help them identify the next generation of abuse and risk.

The reform bill has won the support of Maine Sens. Olympia Snowe and Susan Collins and their Republican colleague Sen. Scott Brown of Massachusetts.

A point that rarely gets made about this historically deep recession — a recession that could have been a depression — is that it was caused by the economy’s elite players. The people and institutions whose business it is to understand — and profit from — the market at its most rarefied levels, made incredibly bad decisions about credit, and they failed again and again to see the tightrope they were walking had no net below it. Recessions can have causes other than those created by the people and institutions who work in the investment industry. Climate change that wreaks havoc on agriculture could cause serious harm to the economy. War and civil unrest also affect national economies. The decline in availability of an essential commodity like oil also could send economies into a tailspin.

But the crash of late 2008 — with the recession actually beginning in December 2007 — is inextricably tied to investors playing high-stakes blackjack, sometimes betting with and against the house at the same time. The nonsensical notions that housing prices could only rise, and that the rise was the same as wealth, also ruled the thinking. And of course, the government regulators we rely on to spot these dangerous trends were restrained by elected officials who cheered on the boom.

A key component of the reform bill is the creation of the Consumer Financial Protection Bureau. This watchdog agency will be under the Federal Reserve and its responsibility is to “put the protection of the vulnerable and financially unsophisticated ahead of the safety and soundness of the banks,” as the Atlantic magazine put it. The final version of the bill excluded auto dealers from its oversight, a loophole that weakens the intent, but which was sought by Republicans. But many businesses that prey on ignorant consumers are included.

Sen. Snowe, a senior member of the Senate Finance Committee, in explaining her support of the bill, said, “It is imperative that we implement an aggressive overhaul of the American financial regulatory system. And this effort must include real and substantial consequences for those whose reckless actions caused the crisis in the first place …” She also hailed some of the changes made to the bill at her request, changes that protected small businesses from the oversight of the consumer protection bureau.

The success of the law can be measured by how well it creates a framework that is at once a stiff enough bulwark against known market forces, yet flexible enough to respond to the latest risky behavior.

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