Financial Reform Bill: Can It Prevent Next Wall Street Crisis?

Last Updated Jun 23, 2010 11:33 AM EDT

Chasing Goldman Sachs by Suzanne McGeeThe financial regulatory reform conference committee is chugging away at its mission: To reconcile differences between the House and Senate versions so the regulatory reform bill can become the law of the land.

So far, the committee has leaned toward the weaker versions of several provisions. It has agreed to put a new financial consumer protection agency within the Federal Reserve, instead of keeping it independent. It reportedly will exempt auto dealers from the rules governing most lenders. Next up: The Volcker rule, which would prohibit banks from operating hedge funds, is about to get a loophole.

Will the bill ultimately protect U.S. markets from another Wall Street meltdown? I asked Suzanne McGee, author of the new book Chasing Goldman Sachs: How the Masters of the Universe Melted Wall Street Down... And Why They'll Take Us To the Brink Again. She argues that Wall Street competitors went crazy with envy, wanting to match the outsized returns of Goldman, its most profitable firm. Risky decisions were rewarded, safe ones weren't, and financiers lost sight of their responsibilities to individual investors and their mission - to provide fuel and grease for a smoothly running economy.

McGee is a contributing editor at Barron's who has written on regulatory reform for CBS MoneyWatch. Here's what she said.

Will this bill fix the problems that led us to the credit crisis?

Some of the provisions may be very helpful. For example, the idea that institutions marketing a package of securitized assets must keep some on their balance sheet. This is tremendously wise. If you have to eat your own cooking, you're a lot more careful about where the produce is coming from.

And higher capital requirements are excellent, because firms had been eroding their capital bases to boost their profits. When those chickens came home to roost, they were left with giant holes in their balance sheets.

Does the legislation go overboard?

I'm not sure about the Volcker rule. It strikes me as a bit heavy-handed.

The big problems come with telling them what business lines they can or cannot be in. What if Goldman or another firm decides the price to pay for cheap capital from the Federal Reserve is too high? Some firms may try to pull themselves out from under the Fed's jurisdiction [by arguing they aren't actually consumer banks but investment firms]. Some may find other ways for them to get around language of legislation.

Wall Street is chock full of creative minds, and if you build a wall and say, there's no door in this wall, a banker will just shrug his shoulders and dig a tunnel and go under or find a hot air balloon and sail over it. They will find a way around the wall to a profitable business.

What about the proposed financial consumer protection agency. That's good, right?

A consumer protection agency is tremendously worthwhile. But a lot of the success will depend on how individuals behave. We can get clear disclosure, but we have to be willing to read that disclosure - and stop doing stupid human investment tricks, like chasing outsized performance.

So could we have another credit crisis, even after this is enacted?

History never actually replicates itself exactly. It's always the things we're not paying attention to that rise up and bite us. It's too early to say where the next crisis will come from. It will take a few years. Will subprime lending be the catalyst? No. But I think it is very possible that the way Wall Street thinks could contribute to another crisis, unless risk management is improved.

Has Wall Street changed?
I haven't seen Wall Street collectively interested in changing the rules of the road. They did seem eager to go back to business as usual, and eager to put pressure on Congress to produce the most benign regulatory reform bill possible.

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