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Borde-nough: What the public doesn’t know can hurt it

Examining Financial Reform

Published: April 30, 2010
Section: Opinions

The backers of the Restoring American Financial Stability Act now before Congress seem to have their hearts in the right place.

A seemingly well-intentioned President Barack Obama told an audience in Quincy, Illinois, on April 28 what he thought the law would accomplish. “Accountability—which means no more bailouts. Closing loopholes—no more trading of things like derivatives in the shadows. Consumer protections—no more deceptive products. A say on pay—so that we give shareholders a more powerful voice.”

Those purposes are good ones. Will the bill accomplish them? Sometimes it might. But it draws few hard legal lines around big banks and companies, giving regulators who are even harder to keep tabs on than Congress too much discretion.

The bill’s most consequential parts would empower new and existing administrative bodies to regulate, supervise and liquidate big, poorly run banks and non-bank companies. Regulators would oversee a pool of money to be collected from big financial institutions. The pool is supposed to obviate the need for future government bailouts. The law gives corporate shareholders a non-binding vote on the question of executive pay.

The bill is complex and lengthy. High finance doesn’t seem to people to affect them in the way that, say, health care does. That may explain why the public is not engaged in the debate about the present bill.

But what the public doesn’t know can hurt it. One of the biggest problems with the bill is that a handful of administrators will decide on regulations in which a small and potentially collusive group of the most powerful companies in the country are most interested.

Unlike Congress, regulators don’t have to explain their choices to constituents. Their new authority will ensure that bankers who had to lobby Congress to get the rules changes embodied in the current bill will now have to make their case only to small expert panels. The same experts will be looking for work at the banks when their terms expire. Moreover, regulators may be only as good as the president who appoints them.

Would a panel full of, say, George W. Bush’s appointees likely be firm with big banks and corporations?

The risks inherent in allowing too much regulatory discretion in this area are vast. A case in point occurred in 2004. The Securities and Exchange Commission—like most regulators, a difficult entity for the public to keep tabs on—changed regulations to allow investment banks to vastly increase the debt they could issue to finance the real estate lending market. Bankers had lobbied the agency for the rule changes, knowing that the changes would permit their large banks to reap large profits by making riskier, higher-interest loans.

The SEC’s decision helped lead to America’s real estate bubble, its bank bailouts, and its current economic problems. But few Americans knew about the decision when it was made. The powers that the new bill will vest in administrative bodies create a similar risk that public entities will quietly act to serve private interests.

The pool of money in regulators’ hands for liquidating companies will not be under Congress’ direct scrutiny. The public will have trouble holding anyone accountable for its misuse—but after sensing the public’s anger over the bailouts, that suits Congress and the president fine. The pool itself is too small to ensure that there will be “no more bailouts.” Taxpayers have lately been asked for much more.

They’ll be asked again.

The risks posed by companies that are too big to be allowed to fail will remain as long as such companies exist. The bill gives regulators some authority to supervise or restructure big, failing companies. But it won’t eliminate bailout demands when a big company encounters problems.

The executive pay provision won’t do much. Shareholders can vote on executive pay, but executives can ignore them when setting it.

But the provision raises interesting questions. If Congress can tinker at the margins of state corporate law with such changes, why can’t it go whole hog? Why doesn’t it directly regulate excessive executive pay in companies that utilize the enormous but often down played privilege of limited liability offered by incorporation?

Indeed, why doesn’t Congress place below state corporate law certain federal minimum standards imposing on corporate management duties to operate companies in a manner that takes account of public as well as private interests?

Why not give shareholders—and federal and state attorneys general acting in the public interest—the right to enforce these duties in federal court? The answer to those questions likely has to do with the power wielded in Congress’ lobbies by big banks and corporations. The financial services bill’s proponents claim to be turning the markets into a regulated field of dreams.

But the strongest players don’t want them to go the distance.