As the Senate lurches toward the goal line on financial reform, senators and staff are doing their best curtail the future financial excesses of bad guys without harming good guys. It’s not easy to do.
Derivatives — How do you curtail “naked” bets without hurting hedges by “end users?” If you’re a farmer or an airline, the last thing you want is higher costs of exchange trading, centralized clearing, and higher capital and margin requirements for hedging corn and jet fuel to reduce risks and increase transparency. Those higher costs could put some firms out of business. How do you distinguish “proprietary” trading from “market making” trading? A trade is a trade. It doesn’t come with an attached electronic note that says, “A good client insisted on buying this, so we had to go short,” or “We hate this client, so we’re going short to screw him and make a lot of money.” As Goldman executives tried to explain at an April 27 Senate hearing, the price of a trade determines how risky it is, not the existence of the trade. In other words, it may be a ripoff if you sell your newly painted clunker for $3,000, but it may be a good deal at $2,000.
Consumer Financial Protection Bureau — Should this new regulatory body cover dentists who extend credit to patients? Should auto dealers be covered? Should small businesses be covered? If they are, they will incur higher costs and bureaucratic interference. Again, some good guys will go out of business, but some bad guys will too. The bad guys don’t go around wearing signs that say “I’m a financial predator.” Should a poor person with a bad credit history pay a higher price for a payday loan? Probably, but some payday lenders enjoy local monopolies that allow them to overcharge. If we limit what they can charge, does that help the poor person who can no longer get a loan? What about debt settlement companies, which step in to help those in over their heads? Most achieve enough debt reduction to justify their fees, but some fly-by-night operators have given the industry a bad name by collecting up front fees and failing to deliver much debt reduction. Will the new CFPB curtail mortgage lending for those who can’t afford it, or will Congress act as it has in the past and push regulators to expand “opportunities” for home ownership?
Bank (fee) tax — Although the $50 billion fee was dropped from the Senate bill, the idea could reappear. Charging large financial institutions a fee of 0.15% of their overall liabilities is a good idea in theory, but making it work in practice will be difficult. Most of the bad actors from the financial crisis are long gone. Why should the ones who survived pay? Well, many of them survived because of the government bailout, but, except for AIG and the auto companies, that money has been paid back at a very good rate of return for the taxpayers. If such a fee is imposed, will the existence of that trust fund embolden financial institutions to take more risks? That was one of the main reasons the fee was dropped.
Bottom line: Separating the bad guys from the good guys is very difficult and costly. As we economists like to say, there are lots of tradeoffs. We need more protection against future financial crises, but how much and at what price?