I keep trying to warn my friends in the Federal Reserve about the tsunami that’s coming their way.
I don’t always agree with Representative Barney Frank (D-MA), but I thought his remarks in yesterday’s
Boston Globe were right on target:
Well-functioning financial markets depend on transparency and confidence that institutions are playing by clearly defined rules. Both were in short supply in the months leading up to the August meltdown and remain so today. Large pools of unregulated capital, often highly leveraged, especially in hedge and private equity funds remain opaque and have been joined by massive sovereign investment funds to transform the financial landscape in ways that are out of reach of regulators here at home and in other wealthy countries. We lack the information that we need to ensure safety and soundness as well as the confidence that comes from the requirements mandating governance and reporting standards that apply to publicly traded companies.
To an important extent these new pools of capital are structured in a fashion that allows them to avoid the scrutiny that is required of firms and financial institutions in the regulated sectors. We should not be surprised. It is a fact of life that investors and firms will seek to innovate their way around whatever regulatory strictures apply, whether they deal with health and safety, labor protections, or reporting obligations. This tendency has been exacerbated by a 30-year attack on the very notion of a regulatory role for governments and loud professions that the market not only knows best, but knows everything.
Our job is to understand the changes in the financial marketplace and consider what we must do to ensure that our regulatory system is able to keep up with those changes. Innovation is as important in financial markets as it is in product markets, but it would be foolish to act as if regulatory structures, designed for a different world, do not have to be as nimble and innovative as those they regulate.
On the other side of this argument we seem to have Fed Chair Ben Bernanke, who argues that lenders have learned their lesson and these problems are being corrected on their own. Now, I happen to believe there is also a lot of truth to what Bernanke is saying here as well. But I would invite those in the Federal Reserve to look a few months down the road and ask how this discussion is going to play out if, as I fear likely, the financial consequences of previous reckless real estate lending continue to grow. Each new report of another failed institution, another family losing their home, another pension fund without the money to pay the retirees, and another decline in real estate prices is going to mean more pressure for the kinds of changes that Representative Frank has called for, and burn more of the political capital of anyone who tries to argue against them.
While I agree with what Representative Frank had to say, the devil is in the details. I would vastly prefer to have the staff at the Federal Reserve craft these reforms. But doing so requires the Fed to get on board now to try to set the direction for this debate, before they get swept aside by a political tsunami.
I’ve never been very good at surfing, but I think I understand the theory. You have to make sure your board is moving before the wave actually reaches you.