Oxley: Extra Regulation Won’t Work
Addressing the questions raised by the recent market calamity and forging the way forward will be among the most difficult issues, both technically and politically, ever faced by Congress.
[IMGCAP(1)]The meltdown was such a significant issue that it must be addressed by the Congress and the Obama administration. The debate is likely to spill into next year, but, as things look now, there will be a financial regulatory reform bill of some sort that will be enacted into law. Having said that, most people sense a loss of momentum in recent weeks, and the final result — barring another major indication of weakness in the markets — may not be as sweeping as was indicated originally.
There is understandable anger at the sectors of the financial services industry responsible for taking us, if not to the brink, then entirely too close to it. For many, the logical resolution of that anger is federal regulation. Nonetheless, given the realities of time constraints and federal resources, there are very real limitations about what new federal efforts at regulation will be able to accomplish. Good intentions are not enough: Whatever is put in place has to work in the real financial marketplace now and for decades to come.
For instance, most able observers of financial regulation concur that regulators should be consolidated in order to provide more efficient oversight. That is not to say that regulatory consolidation is a silver bullet that would have prevented the crisis, but it would provide more coherent oversight. Yet even this relatively modest goal is impossible to achieve, and the main feature of the Obama administration’s reform package is to add another federal regulator, the proposed Consumer Financial Protection Agency.
While there is a great deal of commentary about industry special interests and their effect on the legislative debate, there is significantly less attention paid to entrenched regulatory interests.
Decades ago, if a financial product was derived from something you could eat, it was an agricultural financial product that was traded in Chicago. If the financial product was derived from manufacturing or money, it was traded in New York.
As a result of the history of the agricultural Midwest and the financial East Coast, there are two regulators, the Commodity Futures Trading Commission for agricultural products, metals and energy, and the Securities and Exchange Commission for securities, bonds and mutual funds. The regulation put forth by the CFTC is based on principles, while the regulation put forth by the SEC is based on rules.
Today, however, it’s hard to tell the difference between options and futures. Nonetheless, even the power of the most recent financial crisis has not supplied the fuel that would be necessary to overcome history and the status quo in order to accomplish a merger of the two agencies.
Similarly, most experts believe there are too many banking regulators, and the Office of Thrift Supervision is the agency that is most often mentioned as one that easily could be folded into the Office of the Comptroller of the Currency.
While the administration endorses that effort, its main focus has been on creating a new federal agency to add to the alphabetical pile, the proposed CFPA. As the legislative idea was submitted to Congress by the administration, the new agency would have broad and undefined power to regulate any credit product. Questions about its exact scope and how the agency would interact with existing regulators have yet to be answered.
Certainly, there are worthy federal efforts that should be undertaken as soon as possible, such as a systemic overseer to review macroeconomic trends and their risks to economic stability. However the overseer ultimately is constructed, and whatever powers Congress decides to grant, the overseer must somehow resist the regulatory urge to focus on analyzing what happened in 2007 and 2008. If it is to be effective, the overseer will need to focus on where the financial business is going, not just where it has been.
However, in its zeal to regulate and to provide a federal solution, Congress should not overlook the power of transparency and natural market forces to provide some of the necessary discipline.
Treasury Secretary Timothy Geithner understands this — as do House Financial Services Chairman Barney Frank (D-Mass.) and Senate Banking, Housing and Urban Affairs Chairman Chris Dodd (D-Conn.) — and has proposed that over-the-counter derivatives be exposed to a clearinghouse or an exchange. This effectively would address the core problem with derivatives, that their true value was unknown because they were not exposed to the market forces of clearing and/or trading. No one knew what their value was because there was no price discovery between willing buyers and sellers. The ultimate risk is not knowing what an asset is worth.
Had it not been for the total collapse of derivative value that would have spread counterparty losses and triggered panic, the Bear Stearns and American International Group interventions might have been unnecessary.
Not all good answers to our financial market problems come in the form of a new federal regulation. As just one example of how transparency and market forces might be used as part of the overall solution, the simple market practice of open trading with a transparent price is a powerful antidote to what went wrong with derivatives.
Former Rep. Michael Oxley (R-Ohio), who served as chairman of the House Financial Services Committee from 2001 to 2006, is of counsel with Baker Hostetler in Washington, D.C. He is also senior adviser to the board of directors of NASDAQ OMX. Peggy A. Peterson, senior adviser at Baker Hostetler, contributed to this article.