PALM DESERT, Calif. - The United States is determined to show the world it is leading global economic recovery efforts, even if that means creating what some in the industry view as risky new risk regulators.
Congress has been scrambling for weeks to create a systemic risk regulator before President Barack Obama heads to London this week for the Group of Twenty Finance Ministers and Central Bank Governors, but many financial experts are wondering if the government is rushing too quickly to create new regulations and whether such regulations could have prevented the current financial crisis.
"The banking industry is very heavily regulated, even more so than the mutual fund industry, and we now have a banking crisis of mammoth proportions," Peter Wallison, the Arthur F. Burns Fellow in Financial Policy Studies at the American Enterprise Institute, told an audience at the Investment Company Institute's Mutual Funds and Investment Management Conference here last week.
"The financial crisis today did not come from the failure of any large company; it came from a very large number of bad mortgages," he said. "It cannot be said that the problem today was caused by any large institution. In fact, it was the other way around."
The financial industry has a natural allergy to regulations, but the economic crisis is so severe, the government will need to approach it with the same kind of urgency that led to the 9/11 Commission's creation of the Department of Homeland Security.
"The Obama Administration wants a bill they can go to Europe with," said Jeffrey Brown, senior vice president in the office of legislative and regulatory affairs at Charles Schwab. "There is haste in the House to develop a plan."
Testifying on Thursday before the House Financial Services Committee, Treasury Secretary Timothy Geithner said the U.S. needs "strong and uniform supervision for all financial products marketed to consumers and investors, and tough enforcement of the rules to ensure full accountability for those who violate the public trust."
The Obama plan aims to boost consumer and investor protection, improve international coordination, close regulatory gaps and bring complex, financial products such as hedge funds under federal oversight.
"This debate is always framed as huge regulatory gaps that have to be filled," said Jonathan Katz, former secretary of the Securities and Exchange Commission. "How many of these areas already had regulators that chose not to exercise their authority? If the government is going to address these problems, first it has to figure out what the problems are."
Katz said Depression-era laws were so effective for so long because Congress spent two years methodically creating them. He said rushing to create new regulatory positions will likely add an additional layer of bureaucracy on top of everything.
Echoing White House Chief of Staff Rahm Emanuel's famous comment to "Never let a crisis go to waste," Geithner said the U.S. and countries around the world have an opportunity to use the current financial crisis as an excuse to rebuild the current regulatory framework and prevent future crises from happening. "We have a moment of opportunity now, and we don't want to waste that opportunity," Geithner said.
Not everyone in the increasingly bipartisan Congress is in the same hurry.
"Before we get too far down the road of 'fixing' problems in our regulatory structure, I would argue that more consensus needs to be reached on exactly what the problems are that we are fixing," Rep. Scott Garrett (R-N.J.) said Thursday.
The biggest problem with creating a systemic risk regulator is that nobody has really identified what systemic risk is, Katz said. In short, systemic risk is the total collapse of the financial system. A figurative or literal run on a bank can lead to runs on other banks, quickly snowballing into an avalanche of widespread panic. In a highly correlated global economy, nearly everything is at risk of a meltdown in any one area.
A systemic risk regulator could monitor the broad financial markets, as well as a number of different financial institutions, such as banks, hedge funds, mutual funds and private equity firms. The theory is that if one area appeared to pose a threat to the whole, the systemic cop could step in and rescue it before it failed.
"The downside is that if we do start looking at institutions as special, they will become, in the eyes of the market, too big to fail," Wallison said. "We will have created a virtually unlimited number of Fannie Maes and Freddie Macs."
Wallison asked the audience to imagine an insurance company that was determined to be too big to fail.
"Its agents will say, 'Our company is safer. If you sign up with us, you'll be safer'" he said. "This will be disastrous for competition. And then one firm might fail and cause a meltdown."
Experts fear that when the next financial crisis occurs, a systemic risk regulator would be forced to protect a growing number of companies.
"I've never known a regulator to not be expansive," Brown said. "They will be over-inclusive by nature."
"Whoever gets this job, it will be very difficult to promise that they will always connect these dots,'" said Stuart Kaswell, executive vice president and general counsel of the Managed Funds Association. "If they don't collect enough data and fail to prevent the next crisis, they'll be in trouble, but if they collect too much data and don't stop the next crisis, they'll still be at fault."
"Why does Congress want a systemic risk regulator?" Wallison asked. "It solves Congress' problem, which is that they have to show they are taking some kind of action. It allows them to say, 'We've dealt with this problem. It won't ever happen again.'" The irony is that if not done correctly, creating a systemic risk regulator could create the very sort of systemic risk it was meant to prevent.
"All these financial entities compete with each other for capital and credit," Wallison said. "If the Fed tried to adjust capital on one, it could have an impact on every other area. The result is almost impossible to imagine."
The real problem is not that there is a shortage of regulation, but that various regulators failed to enforce their particular areas or communicate with different agencies and see the broader picture.
"The Fed utterly failed as a regulator," Wallison said. "There is no power you would give to a systemic risk regulator that the Fed doesn't already have. If we think systemically significant companies will stop the next crisis, we're wrong."
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