I have been a strong supporter of candidate and now President Obama and of his administration's policies, including steps taken to stimulate the economy and prevent further damage to our financial institutions.
But the administration's just-released plan for financial reform contains a witch's brew of toxic ingredients that, to quote Shakespeare, "like a Hell broth, boil and bubble."
Under the administration's plan, the Federal Reserve Board, with advice from a newly created Financial Services Oversight Council, could designate any company a Tier 1 financial holding company, or FHC, because of its "size, leverage and interconnectedness."
The Tier 1 designation, under the administration's plan, would require the Fed to "analyze the systemic importance of a firm under stressed economic conditions." Factors to be considered include: "impact the firm's failure would have on the financial system and the economy" and "the firm's criticality as a source of credit for households."
The plan declares that a Tier 1 FHC "should be subject to robust consolidated supervision and regulation," regardless of whether it owns a bank or already is regulated as an FHC.
What is this "robust … supervision and regulation?" It includes all of the restrictions that now apply to every FHC, plus some unspecified additional special treats for those lucky enough to be chosen as Tier 1.
The administration specifically highlights the prohibition against any FHC's engaging in nonfinancial activities. Under the administration's plan, a Tier 1 firm could not engage in a nonfinancial activity, "regardless of whether it controls an insured depository institution."
To maintain what the administration calls "the long-standing wall between banking and commerce," a newly designated Tier 1 financial holding company "should be given five years to conform to the existing [FHC] activity restrictions."
So how would this work in practice?
Let's just suppose that the Treasury and Fed decide that a large automaker (perhaps General Motors?) is systemically important because of the impact its failure would have on the economy. If GM were to shut down, its own large work force would lose their jobs. So would the workers at hundreds of GM dealers and at GM's now bankrupt suppliers. The availability of auto financing or leasing would evaporate.
Indeed, suppose GM were so systemically important that the U.S. government decides to invest billions of dollars in the company to prevent its liquidation.
Yes — it's fantastic to imagine. But just try.
So for these reasons, GM should be classified as a Tier 1 FHC. But then, at the end of five years, GM could no longer engage in nonfinancial activities, like making cars and trucks.
The administration's plan asks Congress to create a Consumer Financial Protection Agency. This agency would be "a single primary federal consumer protection supervisor to protect consumers of credit, savings, payment and other consumer financial products and services and to regulate providers of such products and services."
Among its other duties, the CPFA would take over the writing of Truth-in-Lending and other consumer protection regulations. The plan requires that, in doing so, the CPFA consider the "costs to consumers" but says nothing about the costs to providers.
The agency's regulations would "serve as a floor, not a ceiling." The administration's plan would leave each state "free to adopt stricter laws," which would apply to both state and federally chartered institutions.
Who would enforce these regulations? Not the banking agencies but the CPFA itself — plus, of course, state enforcement agencies. The plan, for example, calls for the CFPA to "maintain a group of examiners specially trained and certified in community development to conduct CRA examinations of larger institutions."
But wait! There's another ingredient.
The CFPA also would "be authorized to define standards for 'plain-vanilla' products that are simpler and have straightforward pricing … [and] to require all providers and intermediaries to offer these products prominently."
The plan uses a 30-year, fixed-rate mortgage to illustrate this forced-to-offer requirement.
But the CFPA also could regulate the offering of other financial services, such as overdraft protection. This new agency could force a bank to offer "plain-vanilla" overdraft protection but "prohibit charging for overdraft coverage" unless the bank met CFPA-prescribed conditions. Individual states also, apparently, could exercise this power.
So a bank might be forced to offer a particular financial product or service but not be allowed to charge enough for the service to cover its costs — much less the risk.
The administration does not explain how limiting fees for government-required services will be reconciled with its demand that an FHC's "risk management standards — should be stricter and more conservative."
"Something wicked this way comes" was how one of Shakespeare's three witches announced the approach of Macbeth. But the weird sister might just as well have been speaking of the administration's financial reform plan.
The plan has other flaws, such as:
- The moral hazard of identifying Tier 1 FHCs (does anyone remember Fannie and Freddie?).
- An unfunded and open-ended financial assistance and resolution scheme.
- A politicized and all-powerful Federal Reserve.
Then we truly have "a charm of powerful trouble."