President-elect Barack Obama and his new administration face many challenging policy issues involving the future of financial services, primarily the next steps to take in resolving this financial crisis and potential reforms. Here are eight suggested areas of focus.
- Many borrowers owe more than their houses are worth, and lenders are reluctant to agree to forgive the rest of the debt for the borrowers who have no equity. Right now this spells gridlock on a critical issue with no easy solution. Loan modification programs by lenders and the government can work, but only for borrowers who can afford to repay the loan under the restructured terms. The real issue is whether the government will step in to buy or guarantee home loans held by the many borrowers who are losing their jobs.
- Uniform national mortgage underwriting standards that establish best practices are long overdue. This will protect everybody: the lender, the borrower, and the loan securitization market. It is widely acknowledged that prudential standards went out the window once mortgage lenders were able to originate and sell loans promptly, getting the loans off their books and on to those of investors. The loan securitization market cannot ever again be turned into the financial version of the game "pass the trash."
- The deposit insurance laws should be changed so that the Deposit Insurance Fund is kept at higher levels during boom economic periods. During the record good times in the housing market over the last 17 years, deposit insurance premiums were kept at a minimum. However, the Deposit Insurance Fund is dwindling — and may face a taxpayer bailout — in the face of mounting bank failures. As a result, the Federal Deposit Insurance Corp. was forced recently to double its assessment rates on an already ailing banking industry.
- The public needs to better understand and trust the deposit insurance guarantee. Over the past year the United States has had deposit runs at a level that has not occurred since the establishment of federal deposit insurance in 1933. The temporary raising of deposit insurance limits under the Emergency Economic Stabilization Act to $250,000 is helpful, but it does not solve the basic problem: In response to adverse publicity or financial disclosure, small savers have been withdrawing deposits from their banks.
- Nonfinancial companies such as retailers and private-equity funds should be permitted to invest their capital in the financial services industry. During the S&L crisis of the 1980s, the eventual taxpayer bailout costs were mitigated by letting nonbanks acquire troubled saving institutions. Investments by nonfinancial companies should be permitted only if they face regulation similar to that of bank holding companies, with strong, prudential firewalls between holding companies and their banking and other financial services affiliates.
- Fannie Mae and Freddie Mac were essentially nationalized. Where do we go from here? Maybe history shows the path to the future. Fannie Mae was founded as a government agency as part of FDR's New Deal to provide liquidity to the mortgage markets by guaranteeing government-issued mortgage-backed securities. Ginnie Mae, formed when Fannie Mae was privatized in 1968 to take it off the government's books for the purposes of raising taxes to fund the Vietnam War, is an agency within the Department of Housing and Urban Development that provides a direct government guarantee of mortgage-backed securities it issues. To date it has reported no significant problems. The future of Fannie and Freddie should be driven by a debate about the relative merits of providing explicit government guarantees and the appropriate level of oversight that comes with such a guarantee.
- All the large U.S. financial institutions are involved in diverse financial activities and are regulated by an alphabet soup of federal and state agencies. There is certainly short-term potential for reorganizing the wide-ranging activities and structure of such agencies, but who regulates what and how should be the paramount concern. In particular, the wave of mergers and acquisitions during this crisis has created ever-larger financial services companies that are not only "too big to fail," but potentially too big to comprehend. How they are regulated is critical to any plans for a restructuring. U.S. regulators should be required by law to have complimentary and overlapping responsibilities regarding these institutions and to share material and supervisory information with one another. One regulator must be charged with global consolidated oversight. The Federal Reserve Board looks like the winner by default right now as the consolidated regulator of this increasing number of large financial companies. However, the question is whether the Fed can do the job alone as currently structured and staffed, consistent with its significant monetary policy and enhanced lending and liquidity-enhancing responsibilities in the financial crisis.
- Savings rates in the United States are among the lowest, and consumer debt levels are among the highest, of any nation in the world. The tax laws should be amended to fully exempt interest earned on savings accounts up to the deposit insurance limits. Banks need money to lend, and people need to save money.
