Make Haste Slowly
This guest post is from Martin Baily, Charles Taylor and Peter Wallison of the Pew Financial Reform Project.
The patchwork of federal agencies that was charged with overseeing the financial system failed to protect us from crisis last year, and everyone in Washington agrees that it needs fixing. However, the regulatory reform debate is proceeding piecemeal and at breakneck speed -- an unnecessarily risky strategy given the stakes involved. The regulatory infrastructure that will be implemented will affect the U.S. and global financial sector for decades to come. A fact-based, bipartisan approach is a much more certain path to get us to where we need to go – toward the creation of a competitive, fair and stable financial system for the 21st century.
There is time to be methodical about reform. It will be a while before financial institutions resume significant credit expansion: The danger of excessive credit creation is a long way off.
What “methodical” means in this context is to proceed deliberately, with deference to the factors that precipitated past crises and with an eye to those that may arise in the future. The legislative process now underway may not do this. Many in Congress are worried that they do not see the full picture yet and there is no clear and widely shared understanding of what caused the current crisis. As interested stakeholders try to preempt the debate in their favor, a foundation of bipartisan understanding of the facts and the issues will be enormously important for keeping the debate on course and ensuring sound and enduring outcomes.
While the administration’s proposed regulatory plan tackles many important problems, there are many questions it does not address -- agency balkanization, the performance of regulators and the rationale for concentrating a great deal of power in a single agency. What is the vision that justifies the shopping list of specific remedies? Will the administration’s plan do enough to reduce the odds of another major crisis? These are big and basic issues.
There must be agreement on the facts. What went wrong and why? Not just in the current crisis, but in other crises in the United States and elsewhere in the world. What is it about financial systems that make them unstable? What were the reasons that regulation failed -- even when there was statutory authority to intervene as things started to go awry?
And, there must be a compelling vision of the future financial system. Could this be a system dominated by large institutions? Could it be one in which traditional divisions between types of institution are maintained in perpetuity? Will deposit-taking continue to contract and other ways of capturing savings continue to expand? Will the system be more, or less, diverse? Congress needs a bipartisan, widely held understanding on the main features it does -- and does not -- want to see in the U.S. financial system as it evolves. Between the start and the end point, Congress needs a view of what regulation should aim to do, to supplement and shape what the private sector will do anyway. With strong governance and appropriate capital structures, how can supervision and regulation add materially to the safety and soundness of institutions? How can supervision be made more effective and supervisors be made more accountable?
It is only when a view has been formed about what regulation should do that it makes sense to decide where regulation and supervision should be carried out. So, for example, the current debate on systemic regulation – whether the Fed or a new council or agency should take the lead – is premature. First we need a view on what systemic risk regulation involves in different states of the financial system. Does it mean monitoring the system for early signs of heightened exposure to systemic risk? Does it necessarily include oversight of “systemically significant” institutions? Once a view on these and many other functions is formed, then Congress can develop a view on the best organization structure to carry out those functions.
These are not unanswerable questions and need not take years to resolve. Bipartisan consensus can be found and forged within the next year. Form follows function; function follows purpose; purpose follows vision. There is enough at stake that Congress should take the time to get it right.
--Martin Baily of the Brookings Institution and Peter Wallison of the American Enterprise Institute are the co-chairs of the Pew Financial Reform Project. Charles Taylor is the project’s director.
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