Personal Finance

The Outlook for Financial Reform

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In the wake of the worst financial disaster in 75 years, there has been a call for additional regulation of financial institutions. In response to these demands, the Obama administration just unveiled an 88-page book that outlines its proposals for overhauling the financial regulatory system. I have not read it yet, but I understand that key among the provisions of this document is increased authority for the Federal Reserve System and the abolition of just one agency, the Office of Thrift Supervision. 

The cry for more regulation is quite understandable as most everyone in America is undergoing financial and emotional stress due to job loss, declining housing values and, severe cuts in values investments (including pension plans), and the other after-effects of the sub-prime bomb.

What I find incredible is that we are jumping ahead in this process. Rather than issue new regulations, what we really need to do is to take a long and very hard look at exactly how the various regulatory agencies were supposed to work and how they failed. We ought to know why the patient got sick before we recommend the cure. Knowing how institutions failed in spite of oversight will allow formation of a much better regimen for the future.

Here's my take. With one notable exception — the FDIC — financial regulators seem to be incredibly ineffective. They publish annual reports that justify their existence, but when it comes to trying to measure their results, much is left to be desired. When a crisis occurs, they always say, "We can’t do our job because we don’t have enough power. We want more laws, more employees, and bigger budgets."

Let's take an example: the Federal housing Finance Agency. This agency is successor in name to the Office of Federal Housing Enterprise Oversight. This agency has had responsibility for overseeing Fannie Mae and Freddie Mac since 1992. During this period, both companies expanded dramatically.

This expansion was due in large part to fact that their biggest competitor in the mortgage field, the Savings & Loan industry, was being dismembered by the hastily created Resolution Trust Corporation in the in the late 1980s and early 1990s. (That debacle was due in part to another gross regulatory failure by the Office of Thrift Supervision, a story for another day.)        

It wasn't like the problems at Fannie and Freddie weren't obvious. There were accounting scandals as well as misstatements of earnings that seem to have been designed to assure that the top management got egregious bonuses. I think that the same stories would pop up if you looked at the inner workings of all the other financial regulators from the Fed to the SEC to the FTC and a myriad of other agencies.

The bottom line is that Congress will NEVER be able to come up with enough rules and enough regulators to supervise the mortgage industry that funds something like 40,000 transactions every day.  It's just not going to happen.

I know this judgment flies in the face of logic to those people who believe that someone riding in on a U.S. Government white horse can fix these things. In spite of the tens of thousands of pages of laws, government has demonstrated no ability to do it in the 30 years that I have been in the business. Another 50,000 pages of laws and another 50,000 bureaucrats isn't going to fix it in the next 30 years either. 

The way to fix this problem is to educate the 10 million people who get loans every year. If you make them smart enough, the shysters out there will not be able to take advantage of them. The tools are there and I think that there is willingness on the part of consumers. You just have to meet them more than half way.  That's a topic for another day.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower
articles, Randy is a mortgage broker who has financed over $1 billion
in properties. He writes about home buying and real estate finance
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