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Financial regulation shaping up as a political battleground

The Obama administration is under pressure to advocate new rules to prevent a repeat of the financial crisis. Many in the GOP, though, believe government causes the problems.

February 03, 2009|Peter G. Gosselin

The problem with a "too big to fail" firm is that the company enjoys an implicit guarantee in advance of any crisis, one it doesn't pay for. That allows it to operate with a kind of impunity, knowing Washington will ride to the rescue if it gets into trouble. The assumption also lulls investors into a false sense of security.

"Implicit guarantees may well be the worst kind of government guarantee," said Harvard economic historian David A. Moss, on whose work much of the Democratic proposal was based. "They are ill-defined, open-ended and almost impossible to get rid of."

The Democratic panelists' solution: Have Washington sort financial firms into those that have "systemic significance" and those that don't. The first group would face much stricter regulations, such as requirements that they maintain larger capital cushions in case of trouble, limits on the business they can do with borrowed funds and perhaps even payment of premiums to the government for "capital insurance."

"Right now, we have lots of implicit guarantees. We say, 'We'll guarantee you, but we won't regulate you,' " Warren said. The panel majority, she said, proposes that "we make those implicit guarantees explicit."

In calling for the changes, the majority cited work by Moss showing that strict regulation during the half-century between the New Deal and the Reagan revolution produced an era with few financial failures, but loose regulation both before and after resulted in many more failures and a string of financial panics.

Singling out "systemically significant" firms and imposing stricter regulations would alter the financial terrain and, perhaps, transform such giants as Goldman, Sachs & Co. and JPMorgan Chase & Co. from innovative powerhouses into much more controlled and subdued operations.

In a portent of the arguments that will be made against ratcheting up regulation, the panel's two Republicans, Sununu and Rep. Jeb Hensarling of Texas, issued a lengthy counter to the majority's report, arguing that it was government rules, not the actions of business, that caused the current crisis.

The pair accept the need for a government bailout to address the crisis and endorse modest new rules to prevent similar calamities in the future. But they train most of their attention on Fannie Mae and Freddie Mac, the failed government-created mortgage giants.

Sununu and Hensarling argued that the two firms so distorted the housing market that they made a financial breakdown inevitable. Relying on the work of Wallison, the Reagan-era deregulator, the two men use Fannie and Freddie as evidence that Washington, not Wall Street, is the villain in the drama.

"The current crisis was caused by excessive government involvement in the economy, and the way to address it is to get the government out," Wallison said. The Democrats, he complained, want to head in the opposite direction.

Last week, it was dueling reports. But when the Obama administration begins to unveil its big-picture plan for setting the economy aright, the battle over regulation will break out on a wide front.

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peter.gosselin@latimes.com

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