Why Everyone Is Right About Regulatory Reform

(MoneyWatch)  The President's proposed overhaul of financial regulation has to be doing something right because it seems to be making so many different people unhappy. Douglas Elliot, a fellow at the liberal Brookings Institution, calls the plan largely sensible, but worries that it's vulnerable to being watered down by interest groups in Congress. Economist Simon Johnson, writing in his blog Baseline Scenario about Tim Geithner and Larry Summers' trial balloon proposal in the Washington Post on Monday, frets that the proposal simply lays the groundwork for an even worse meltdown, presumably because it doesn't go far enough. On the conservative side, the Washington Research Group, which writes about policy for the financial services industry, says the proposal is "about as negative as the industry feared."

And at this point, they're all right.

Naturally, the proposal is going to change tremendously as it makes its way through the legislative sausage factory. The Senate probably can't take up the measure before fall -- they have the small matter of health care reform to attend to, as well -- which gives the financial services industry time to organize against it. Washington Research Group estimates that no more than 10 percent of the proposal will make it into law.

And there is a lot here for the financial services industry to want to organize against. Higher capital costs and stricter rules will drive up costs and shave profit margins. The industry's ability to come up with ever more complicated, higher profit consumer products will be crimped by the proposed Consumer Financial Protection Agency. Brokers will have to become fiduciaries and put their customers' interests first, a development my colleague Jill Schlesinger has long argued for. Good for consumers, bad for profits.

And of course, the new regulations will certainly lay the foundation of the next crisis. They always do. The question is how long it will take before the industry finds the loopholes to exploit and then, inevitably, overdo. It took just eight years for the Commodities Futures Modernization Act of 2000, the law that deregulated credit default swaps, to self-destruct. You can't regulate human nature.

But that doesn't mean you don't have to try. You'll hear a lot as the lobbying gets into gear about how the regulations will raise costs and inhibit financial innovation. They will. But the cost of dialing back the risk in the system and levelling the playing field between the industry and consumers can't be as high as the cost of the unbridled greed that brought us to this point. The regulations created after the Great Depression eventually failed, but they kept the system relatively fair for 70 years. That would be nice to shoot for here.