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Is financial regulation badly needed reform or an overreaction?

This article first appeared in the St. Louis Beacon, June 25, 2010 -  President Barack Obama calls the financial regulation package worked out by members of the House and Senate "the toughest financial reform since the ones we created in the aftermath of the Great Depression." (Click here to read the president's full remarks.)

Max Cook, president of the Missouri Bankers Association, has a slightly different view.

"If I was a consumer, a business person, the head of a household, and I saw what is happening to the banking industry in this country, I'd be outraged," Cook said in an interview Friday, after details of the agreement were released following marathon negotiations in Washington.

"It's going to force a lot of smaller institutions in this country out of business, not because of competition but because of costs, and that is not what government is supposed to do."

The House and Senate are expected to vote on the package next week, with an eye toward approving a bill for the president's signature by July 4.

The legislation includes provisions:

  • to restrict the ability of banks to engage in securities trades for their own benefit;
  • to give the government new power to seize large firms whose actions threaten the nation's financial stability, without taxpayer bailouts;
  • to create a new, 10-member Financial Stability Oversight Council to monitor the nation's financial system;
  • and to provide for new consumer protection in mortgages, credit cards and other loans.

Cook says that legislation intended to help consumers will actually hurt them, as they end up with fewer institutions that will serve their needs.
But Joseph Haslag, an economics professor at the University of Missouri at Columbia, says that while the impending regulations may increase costs to a degree, many banks will find a way around them, sooner or later.

The bigger problem, he added, is that new laws can't be used to counter basic human instinct.

"It's not the derivatives or the swaps or any of the other complicated financial contracts that are problems by themselves," said Haslag, who holds the Kenneth Lay chair in economics at Mizzou. "They are mechanisms that parcel out risk. People see these as ways to make big gambles, and there are risks in the world. If you line up your gambles all in one direction, and the risks come out in a certain way, you can lose a lot of money.

"The bill could have gone a lot further and raised the costs a lot more and it still wouldn't put an end to these kinds of financial crises. They are part of human nature. If people see a way to enrich themselves, they're going to find clever ways to do so. You can't legislate people's self-interest and behaviors."

Hillary Sale, a law professor at Washington University whose specialty is securities, called the proposals "a big step forward," even though they don't address all of the issues that people wanted to see addressed.

"All the corporate governance measures are gone," she noted. "It's a fair debate about whether that is good, bad or indifferent. Most of what they are is gone. I am less concerned about giving shareholders a voice than some people are. The bill is strong on financial reform but weak on conflicts reform."

Asked whether Congress is moving back toward the restrictions of the old Glass-Steagall law, which separated investment banks from savings institutions -- and was largely repealed in 1999 -- Sale said:

"What happened with the repeal of Glass-Steagall was an 'all bets are off' attitude. Add to that increasingly complex risks and investments, and regulators can't keep up. So pulling back on that, making derivatives subject to some form of regulation and putting limits on the activities that banks can engage in, those are good things.

"To tell banks they can no longer engage in certain kinds of profit-making activity, and do it because they are taking risks that are unnecessary, that's a big deal. To build in some requirement that banks hold on to a big piece of mortgages, that's a big deal. But like most things, the reality of this will all be in the fine print -- not the fine print of the legislation but in the regulations."

The view of Cook, the head of the Missouri Bankers Association, is not so positive. He says the entire package is an overreaction that has little to do with the causes of the financial meltdown in 2008. Instead, he said, new rules that are supposedly designed to help consumers will actually end up hurting them.

"Portions of it ultimately could restrict credit," he said. "There is absolutely no doubt that the legislation is going to cost the banking industry billions and billions and billions of dollar in added costs, and the end result of those increased costs will be increased costs to the consumer.

"That is not what we need to be doing at this time. We need to be finding ways to increase credit and lower the costs for business and industry and households and individuals to spur economic activity."

The problem, Cook added, is that instead of taking aim at the large institutions that triggered the problems, the bill will hurt all financial institutions.

"We had a ton of mortgage brokers, finance companies, payday lenders, all kinds of folks with little or no regulation who were perpetrating acts against borrowers that need to be addressed. We agreed with that. But if you analyze this legislation, it does very little to address those problem areas. They applied them to commercial banks that didn't cause the problems.

"The traditional banks, community banks, had nothing to do with the meltdown that occurred. We didn't make the risky loans. We were trying to keep our communities healthy and strong and vibrant. Now, they have put together a series of laws in this package that are going to put new regulations on these banks. Community banks in this country already are overburdened with regulation. We had 50 new ones just in the last couple of year, and now they're adding 30 more."

The result, Cook said, will be increased costs and fewer opportunities for businesses that aren't in a position right now to handle much more.

"We run the risk of losing hometown institutions," he said, "and when the hometown bank goes, Main Street is in trouble, too. Those who are left behind don't have the same interest and the same desire to care for that small town and its Main Street.

"As a public, we need to step back from this. We need to take a hard look at what is being proposed and ask if this is really what needs to be done. If not, let's put a halt to it before it's too late."

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