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Republicans and Democrats agree on financial reform -- but is that a good thing?

The important takeaway from the Republican FinReg proposal is that they ... basically agree with the Democrats. At least on the big-picture stuff. They agree that the correct questions for financial reform are "how much information, and how much power, do regulators have?" In fact, their main differences with the Democrats are when they give politicians and regulators more discretionary power than Dodd does.

For instance, in the Dodd bill, the Treasury Department, FDIC and Federal Reserve all need to agree that a firm is failing in order for it to be taken over. In the Republican bill, the president and the D.C. district court also need to sign onto the decision. The question in both bills is whether there's any chance that the government will take down a firm before its imminent collapse sparks a crisis. It's too-big-to-fail meets too-hard-to-intervene.

Another example: In the Dodd bill, virtually all derivatives go through a clearinghouse so regulators can see what's happening and companies have to keep sufficient cash on hand to pay off their bets. In the Republican bill, the SEC, the Commodity Futures Trading Commission, and the Federal Reserve Board of Governors will write up regulations for which types of derivatives have to be cleared.

So if you basically liked the Dodd bill but were looking to give regulators just a little bit more discretion, then the Republicans are here for you (for a more comprehensive side-by-side comparison, head here). But what if you think that the financial sector itself is broken, and even good regulators can't fix a broken sector?

Here I'd direct you to Arnold Kling's 8-point FinReg fantasy. Kling is an adjunct scholar at Cato and a former economist at the Federal Reserve, but his plan -- which includes getting Fannie and Freddie out of the mortgage market, breaking up big banks, and making derivatives less attractive by deprioritizing them in bankruptcy hearings -- doesn't read like the Republican plan and it doesn't read like the Democratic plan.

The argument over the policy of financial reform -- which is distinct from its politics -- is not between Republicans and Democrats, or even liberals and conservatives. It's between people who think the financial sector needs to be changed and people who think we just need to give the regulators more information, power, and instructions so they can look after it better. Kling is a libertarian and I'm not, but we're probably closer on this than I am to either the Democratic or Republican proposal.

By Ezra Klein  |  April 28, 2010; 9:39 AM ET
Categories:  Financial Regulation  
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Comments

Ezra,

I like the proposal better than either Dem or Rep proposal as well but you don't have problems with his point #2?? He uses the "V" word!

Posted by: visionbrkr | April 28, 2010 9:53 AM | Report abuse

Oh, I have problems with plenty on Kling's list. But I appreciate his approach.

Posted by: Ezra Klein | April 28, 2010 9:56 AM | Report abuse

The Bush administration proved what's wrong with discretionary oversight. As a believer in "free markets," his regulators chose not to regulate or were to busy looking at porn to do so.

Posted by: harwoodoffice | April 28, 2010 10:43 AM | Report abuse

The Dodd bill is better on derivatives, and the Republican bill is better on take-overs. And I say that because I think it should be very hard for the government to take over, but that derivatives should be as transparent as possible, and only sold through open exchanges.

I like Kling on Fannie and Freddie, but you don't even have to get them out of the mortgage market, just scale back their scope until they are working at the scale they were originally intended. There's nothing wrong with helping folks with no credit get low downpayment loans on starter homes. But Fannie and Freddie got in the business (as I understand it) of buying paper on much more expensive homes, often on mortgagees who didn't lack credit but actively had very bad credit.

And, though I enjoy the mortgage interest deduction, I would get rid of it, too. I'd rather see something that would help home buyers build up equity more rapidly. I'd even be open to a lower downpayment, but with an extra $50 or $100 or $200 (depending on the size of the loan) tacked on to the payment to help the homeowner build up equity much faster. When there's real equity in a house, it's a greater incentive to avoid foreclosure, it's a greater incentive to sell rather than abandon, and it provides real capital once the property is sold, rather than just enough to pay the realtor.

I'd support a law that mandated lenders could not make loans with the intent of exploiting borrower ignorance, but, even more, I'd like to see consumer loans limited to fixed-rate, 10% down, with an option to get a quarter-point knocked off if you put 20% down.

Getting rid of the corporate income tax isn't the way to go. It should be lowered. If it was lowered to 10%, it would probably have the same effect on excess leverage as eliminating it, would lead to less taking of profits over time, potentially help spur the economy and increase the actual tax receipts. But I don't think we're likely to see a corporate tax cut in either FinReg bill.

On the whole, I think any of the presented plans are probably better than the status quo.

Posted by: Kevin_Willis | April 28, 2010 10:45 AM | Report abuse

Ezra,
Arghh! Kling wants to get rid of the mortgage deduction. How upset do you want to make the American public?

Posted by: moiraeve1 | April 28, 2010 10:52 AM | Report abuse

The answer to the question which is the caption to Ezra's column is

"NO" !!

Next question?

Posted by: ernie1241 | April 28, 2010 12:24 PM | Report abuse

After listening to the Cabal from Goldman -as witnesses - it's perhaps not obvious to ALL that what happened on Wall Street was mandated by (previous) Congress. In other words, there was nothing illegal what Goldman did or didn't do with mortgages in toto!

It's a very unplesant but an objective reality; ie. deregulation was and still is the culprit.

Me thinks one basic criteria must be to limit the growing share of non-productive financial sector to GDP - going forward.
Too big to fail is basically a cliche for dummies to be fooled by....

Posted by: hariknaidu | April 28, 2010 12:47 PM | Report abuse

Opacity reduces scrutiny and confers power on the few with the ability to pierce the veil. Although derivatives have indeed become extremely complex, in actuality, they are as old as the idea of finance itself. The credit derivatives market should borrow a thought from Leonardo: “Simplicity is the highest form of sophistication.”

For a clearer understanding of subprime mortgage-backed credit derivatives, visit:

http://donovanlawgroup.wordpress.com/2010/02/19/how-credit-derivatives-brought-the-u-s-economy-to-the-brink-of-a-second-great-depression/

Posted by: brianjdonovan | April 28, 2010 1:12 PM | Report abuse

This country is ruled by two criminal organizations called the "Democrats" and the "Republicans". Usually, these two gangs fight over the spoils that they loot from the public treasury and we, the people, are too stupid to do anything other than cheer for one or the other. Sometimes, though, the two groups of vermin join together in order to screw the people over extra-good. They call that "bipartisanship" and we're supposed to be happy because they're getting along.

We have the government we deserve.

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Posted by: jordaner004 | April 28, 2010 1:56 PM | Report abuse

The IMF has done some really interesting research on the role that lobbying played in bringing on the financial crisis. Overview and more info: http://www.youtube.com/watch?v=ey2S4-qOIRc

Posted by: financialwatcher | April 28, 2010 4:03 PM | Report abuse

I really like this line from Kling:
"The overarching principle I have is that we should try to make the financial system easy to fix. The more you try to make it harder to break, the more recklessly people will behave. By reducing the incentives for debt finance and for exotic finance, you help promote a financial system that breaks the way the Dotcom bubble broke, with much lesser secondary consequences."

Equity bubbles hurt, debt bubbles kill.

Posted by: staticvars | April 28, 2010 5:07 PM | Report abuse

The Kling plan doesn't sound very libertarian either. Forcibly breaking up banks seems very statist.

Posted by: zosima | April 28, 2010 7:29 PM | Report abuse

The Republicans are also posturing to de-fang any consumer protections, and we all know that its a perennial favorite for the GOP to disempower, or even block, any consumer protections.

Posted by: RalfW | April 28, 2010 10:54 PM | Report abuse

The Repubs are only pretending because the overhaul is overwhelmingly supported by the public. When they get through watering it down further to the approval of their corporate masters it will accomplish nothing. Like the fund paid for by the banks, do you think the banks are happy with that ? So now no fund. Dems need to show some spine.

Posted by: Falmouth1 | April 29, 2010 7:00 AM | Report abuse

Jettisoning an insurance fund as part of the legislative package seems like a pretty safe way to all but guarantee that tax-payers will be on the hook once again.

A large bank will fail again in the future. That much we know (what's unknown is whether it will be a couple years, 10 years, or 20 -- it will happen).

Rather than establishing a resolution fund we get the prospect of . . . .

more taxpayer funded bailouts. Especially if the legislation also punts on size, leverage, and relationships between financial firms.

Apparently eliminating an insurance fund was one of the Big Banks conditions for supporting any legislation. Not surprisingly the elimination of this fund also appears to have been a condition for the GOP to break its filibuster on debate.

Members of both political parties -- and the political parties themselves -- are captured to varying degrees by the Street. Odds are we end up with symbolic reform that improves things around the margins, rather than substantive fundamental reform which ensures 50 years a financial stability.

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