By | March 26, 2008
The talk of New York and Washington this week is whether investment banks are in for increased federal regulation as a quid pro quo for the Federal Reserve lending them funds via the discount rate window. Don't hold your breath.
Last week, the Fed generously extended special borrowing privileges previously reserved for commercial banks to a broad range of financial institutions. Some of the largest financial institutions, such as Goldman Sachs, quickly availed themselves of this additional liquidity.
The Fed has little, if any, interest in regulating investment banks. Such disinterest is not widely shared in Washington, however, where regulation is all too often a measure of political power.
The chairman of the powerful House Financial Services Committee, Rep. Barney Frank, a Democrat of Massachusetts, wasted little time in outlining his new vision of financial regulation in a speech to the Greater Boston Chamber of Commerce. In addition to promoting his housing crisis legislation, Mr. Frank called for Congress to create a new Financial Services Systemic Risk Regulator. This regulator would have the capacity to assess and regulate financial risk at financial institutions. Those entities that avail themselves of the Fed's discount rate would be subject to this new form of regulation under Mr. Frank's plan.
Like millions of Americans, Mr. Frank has correctly deduced that something went dreadfully wrong with risk management at Bear Stearns and many other financial institutions. But Mr. Frank's prescription of more financial regulation is exactly wrong.
Like Mr. Frank, the chairman of the Senate Banking Committee, Senator Dodd, a Democrat of Connecticut, introduced housing crisis legislation that aims to cure our financial crisis the old-fashioned way, with more federal money. Mr. Dodd and others in the Senate, including Senator Schumer, are supposedly working on legislation to overhaul financial services regulation.
Even the administration has called for changes in regulating financial services. Secretary Paulson, for example, is calling for tougher mortgage lending rules.
All of the dramatic talk of increased regulation of financial services makes good sound bites for television, but don't expect major changes to come anytime soon. Here is a rundown of the major issues:
• Legislation to overhaul an existing regulatory agency, much less to create a brand-new one, usually takes years to draft, negotiate, and leaven. Legislative proposals of the past week, no matter how sincerely motivated, simply are initial conceptual sketches of new legal edifices.
• Congress passes few major substantive pieces of legislation in any year, and it is even less likely deep into a presidential election year of a second-term president.
• Democrats control both houses of Congress, have reasonable expectations of taking the White House, and will likely further strengthen their congressional majorities, particularly in the Senate. Democratic congressional leaders are loathe to negotiate the details of legislation with a president who will not be around next year, or with congressional Republicans who also will only be around in reduced numbers.
• If the Democrats take the White House and expand their majorities in Congress in the November elections, it will likely be well into 2009 or even early 2010 before major financial services regulation legislation has any chance of passage. Uncomplicated legislation can pass in the early days of a new Congress. Financial services regulation, certainly of the form that would likely come out of a Democratic Congress next year, will be anything but uncomplicated.
Financial services firms can borrow from the Fed with little threat of retribution, at least for another 18 months or until the Fed closes its lending window to investment banks. That outcome is far more likely than major new federal regulation.
A former FCC commissioner, Mr. Furchtgott-Roth is president of Furchtgott-Roth Economic Enterprises. He can be reached at hfr@furchtgott-roth.com.
