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Roosevelt and Obama

From a recently published academic paper: “Populist Retribution and International Competition in Financial Services Regulation”

Adam C. Pritchard
University of Michigan Law School

~~~ “… The bottom line for Roosevelt was that populist anger against the bankers provided him with the political capital he needed to fundamentally reshape the financial sector in the United States.

Roosevelt succeeded in breaking up the commercial/investment banking giants, curtailing the most aggressive selling tactics of the securities underwriters, and putting the New York Stock Exchange and its broker-dealer members under the watchful eye of the newly created SEC.

Roosevelt won a great political victory against the capitalists, but he did so in a world in which capital markets were generally fragmented on a country specific basis.

Is Barack Obama likely to have the same success in reshaping finance in a world of integrated capital markets?

B. Now: Obama

Simply based on the sheer number of proposals made, Obama’s vision of regulatory reform equals Roosevelt’s in its ambition.15 But once one delves into the details, some aspects of the plan look rather timid. Raising capital requirements was a given of any reform.16 But imposing more stringent capital requirements on the largest banks provides an implicit list – and accompanying subsidy — of the institutions that the government deemed “too big to fail.”

The moral hazard problem created by “too big to fail” is the central problem of reform.

Obama’s plan addresses that problem with a conservatorship provision that would wipe out equity holders.17 The administration tacitly rejected reform proposals to directly reduce the size of banks, as some – like Alan Greenspan – have urged.18 This exposed Obama’s left flank, as some lawmakers pursued legislation that would break up the banks, either based on size, or by restoring the Glass-Steagall limits that precluded the combination of investment and commercial banking.19

Notably absent from Obama’s proposal is any consolidation of agencies. There is some shuffling of agencies, with a new National Bank Supervisor to be created, while the Office of Thrift Supervision is to get the axe. But the alphabet soup of banking regulators continues, albeit with augmented powers. The long-standing jurisdictional overlap between the SEC and Commodity Futures Trading Commission (“CFTC”) is not eliminated by combining the agencies; instead, Obama’s administration has instructed the agencies to play nice through greater harmonization.

Charged with a wholesale overhaul of the regulatory system, the administration appears to have sought the path of least resistance in carrying out that mandate, at least when it comes to dealing with entrenched bureaucracies – and the Congressional patrons who love them. When it comes to vesting those agencies with new mandates and new authority, however, Obama is anything but cautious. Most telling is the extension of government authority into previously unregulated territory.

The Obama administration’s plan greatly expands the powers for the Federal Reserve, setting it up as an “uber-regulator” charged with controlling systemic risk.

A new Consumer Financial Protection Agency would be created to protect consumers by overseeing credit cards and mortgages. Over-the-counter derivatives would be forced on exchange, and therefore, into the regulated sphere. Hedge funds, private equity funds, and venture capital firms would be required to register with the SEC, with hedge funds would be subject to particular scrutiny.20

This last set of proposals is particularly puzzling. No one has seriously suggested that hedge funds, private equity, or venture capitalists played any role in causing the financial crisis. If anything, hedge funds are useful antidote to a bubble mentality. Private equity and venture capitalists are essentially irrelevant to that problem; they operate in a totally different sphere.

So why add more regulation to one of the few bright spots in the financial services industry? As Rahm Emanuel noted shortly after Obama’s election, “You never want a serious crisis to go to waste.”21 Hedge fund managers are (at least some of them) incredibly wealthy people. These are people well?positioned to make political contributions to head off draconian regulation.22 Given the inevitability of compromise, however, draconian regulation is never the first step.

The first step is registration, and a bit of disclosure. Once that beachhead has been secured, truly invasive regulation becomes a credible threat in the wake of the next scandal. That credible regulatory threat is essential to the ability of politicians to extract contributions from the regulated industry.23 Contribute, or we’ll regulate! Regulation – or more accurately, the political class that feeds off it – abhors a vacuum.

Another objection that might be raised to the overall expansion of government power is that for every failed market institution in the late crisis, one can also point a finger at a corresponding failed regulatory institution.24 American International Group (“AIG”) imploded as a consequence of lax risk management? The Office of Thrift Supervision had jurisdiction, but failed to exercise it.

Turning to the big investment banks, Lehman, Bear Stearns, and Merrill Lynch all over extended themselves. The SEC oversaw their capital requirements (or lack thereof).  Credit rating agencies failed to predict the meltdown of the market for mortgage backed securities? The SEC had recently been given greater regulatory authority over the industry.

Mortgages extended to borrowers with little hope of repaying? Freddie Mac and Fannie Mae were there to guarantee the loans, backed by an implicit government backstop.

Roosevelt had the advantage of being able to point the finger exclusively at the financiers. If there was a regulatory failure, it was at the state level. The states’ failure to adequately grapple with the problems merely reinforced the need for federal intervention.

Roosevelt plowed virgin regulatory ground for the federal government. Obama, by contrast, is stuck with a singularly awkward fact: the regulatory failure of the mortgage crisis was at the hands of the regulators who are now to be charged with preventing the recurrence of the crisis.

This is less than satisfying for voters keen on retribution. Political morality plays are more compelling when there is a clean division between the white hats and the black hats….”~~~

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