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Your Turn: A Financial Product Safety Commission?

Starting at 10 this morning, the investigations and oversight subcommittee (part of the House Committee on Science and Technology) will hold a hearing on “The Science of Insolvency.”

Chairman Brad Miller (D-N.C.) apparently wants to explore what we know and don’t know about how to measure and enforce the insolvency of big banks – measurement is the science, but presumably enforcement is more of an art. He’s worried, as are many, that creating banks that are Too Big To Fail distorts the financial system and hurts ordinary consumers – for example, by creating the conditions for a financial crash and deep recession.

Miller is also an outspoken advocate of a kind of Consumer Financial Product Safety Commission – the idea is to inform and protect Americans on personal finance they way they are protected (or are supposed to be protected) on things like auto safety and baby cribs. I strongly suspect that this idea will work its way into the discussion.

Jeffrey Sachs may talk about the need for new taxes to pay for the Obama administration’s agenda, as well as for the financial-sector cleanup inherited from previous administrations. Jeff likes to give it to you straight, without any sugarcoating, and is obviously concerned about our government's solvency.

Dean Baker, a prominent blogger, is likely to emphasize what went wrong with housing, a subject on which he is a leading expert. I suspect that he will strongly Miller on a financial safety commission; too many consumers were misled, one way or another.

I’ll talk about the political economy of how our financial system got to where it is, building on the article James Kwak and I published in the May edition of the Atlantic. My main concern is the way certain pro-finance and anti-consumer ideas have become entrenched in Washington (e.g., “We must protect the big banks above all else”) and how to change that.

The fourth witness is David John, best known for his ideas on how to change Social Security. At least in the past, he favored the further deregulation of banking. It will be interesting to see whether and how he has altered his views.

By Simon Johnson  |  May 19, 2009; 5:57 AM ET
Categories:  Banking , The Hearing Poll  
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Next: Should the Government Get in the Credit Ratings Business?

Comments

I'd like to see a widely publicized "acid test" for banks: liquid assets to deposits and other liabilities guaranteed by the FDIC. Liquid assets would mean cash and marketable securities (those that really can be sold into functioning markets at a market price) and good loans (meaning loans not adversely classified or "watch-listed" by any regulator or internal credit review function). It would give consumers a way to assess the safety of a bank without having to consider the value (or valuation methodology) of impaired assets or the complexity of capital structures. Were the ratio widely publicized, it might be possible to introduce some regulation of banks using market mechanisms. For instance, banks with higher asset coverage ratios relative to FDIC liabilities might be able to attract deposits at lower rates than those with lower ratios. Consumers might come to discriminate between the stronger and the weaker on the basis of the acid test when deciding where to open deposit accounts. Within the banks, fear of even a small decline in core deposits (to say nothing of a run) would be an inducement to maintain high asset quality and avoid risk. As a policy matter, it seems that deposit insurance to protect the consumer has the unintended consequence of shielding insured institutions from the consequences of poor lending decisions. Supervision alone has shown itself to be inadequate in the regulation of asset quality. From one point of view, a bank is a retail outlet for obligations of the US taxpayer equivalent to Treasury securities and banks are asset managers in a highly levered, no recourse private-public investment partnership (PPIP) in which taxpayer shares non of the upside. Congress should be talking more in economic terms about a fair quid pro quo for such a license to make money than about regulation, which implies some kind of imposition on freedom.

Posted by: rfreudthroneofdebtcom | May 19, 2009 11:23 AM | Report abuse

This commission is a healthy idea - but to be really effective, it needs to be able to act as a separate entity from the Fed/FDIC/OCC/OTS/NCUA policymakers.

As a mid-level compliance officer who has been in the industry for over 10 years, it's clear that what happens in a regulatory compliance exam is that examiners who find consumer compliance violations cannot simply issue findings - they have to get clearance from supervisors and policymakers in Washington. Findings with real cost implications are negotiated, often out of existence, because the policymakers are captured by the banks claims that enforcement will have a safety and soundness impact.

A separate Commission, reporting to Congress, that did not make policy, but simply enforced the policy decisions of the banking agencies from the executive branch, would provide a more meaningful check and balance against regulatory capture.

Posted by: esdewey | May 19, 2009 11:47 AM | Report abuse

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