Now that a plan to help the economy recover has been implemented, it’s time to look back at the causes of the biggest downturn since the Great Depression. Identifying the causes of the collapse are key to ensuring that such a catastrophe is avoided in the future.
The “more regulations and oversight” bandwagon was loaded with both Democrats and Republicans in the fall, but inevitably, as the economy recovers, many will hop off. Therefore, the time to remake the regulatory world is short.
The Obama administration is proposing a series of reforms to banking regulations. The main thrust is to centralize regulation of the banking industry under one agency, rather than the current patchwork of groups. The administration has not released details of its plan, but according to the Wash-ington Post, it favors giving the Federal Reserve more power to assess risks within the banking system. The plan would give the Federal Reserve oversight of previously unregulated markets, such as the now infamous derivatives trading sector and hedge funds.
Currently, the Federal Reserve and three other federal agencies regulate banks. As it now stands, banks can choose which regulatory body to use. And according to the Post, since two of the three are funded by bank fees, “the regulators have an incentive to compete for business by offering more le-nient oversight.”
The administration also is considering a new agency to act on behalf of consumers as they use mortgages and credit cards. Whether the new agency’s role is to protect consumers from themselves or from predatory lending, it is needed.
The idea of centralizing banking oversight is sound in principle, just as creating a central Department of Homeland Security was a sensible approach to protecting the nation against terrorism. If the Federal Reserve emerges as the central agency, the administration ought to consider broadening its representation. The Fed’s seven members, nominated by the president and confirmed by the Senate, serve 14-year terms. If its membership were expanded to include consumer advocates, it would function more effectively.
And as important as it is to look forward, a look back is also needed. Two decisions loom large in the rear view mirror — the repeal of the Glass-Steagall Act in 1999, and the law passed in December 2000 that allowed credit default swaps.
Glass-Steagall, created in 1933 as a reaction to the Great Depression, built a wall between investment banks — those that buy and sell stocks — and commercial banks — those that loan money through mortgages. The modern economy, proponents argued in the heady days of 1999, no longer needed that wall.
And when the credit default swap, a complicated investment instrument that has the investor earning a pay-off if a loan or bond defaults, was created in 1997, the institutions that relied on them argued they should be outside the purview of regulators. The Republican Congress passed the law al-lowing them to remain unregulated, and Democratic President Bill Clinton signed the bill.
Even at the risk of constricting a rapidly expanding economy, regulation of the nation’s financial systems is essential to avoiding another meltdown.