Four Questions About Obama's Financial Reform

Last Updated Sep 15, 2009 9:30 AM EDT

Today the President outlined, in general terms, the principles of the financial reform package that he would like to see. Good thing: I was worried that the health care debate and the stock market recovery had made him forget all about it.

My colleague Jill Schlesinger is even more concerned than I am about that. But surely the political will to punish the banks that led the country to the brink of a depression is at least as strong as the will to reform health care. After all, most Americans are more or less comfortable with their health insurance. But no one wants to see a replay of the fall of 2008 - or to see another banker get another zillion-dollar bonus.

The broad outlines of a reform package, including the creation of a long-overdue consumer financial protection agency, have been around since this spring. Inevitably, though, the model will be civil servants overseeing Wall Street Masters of the Universe, same as always. I have a few modest questions about that.

How do you keep regulators from being outgunned? Pitting bureaucrats on government salaries against the most highly compensated people in the U.S. is a bit like sending cops with .38s onto the street against gangs armed with automatic weapons. The SEC's own investigation of its failure to bust Bernie Madoff described how its investigators were dazzled by Madoff's wealth and power. What will keep that from happening again, particularly when every financial regulator eventually wants to go work for the incredibly lucrative industry they've been overseeing?

How do you regulate risks that are too complex to figure out without a Ph. D.? During the last wave of regulatory reform in the 1930s, there were no derivatives, no CDOs or credit default swaps. It's clear now that neither the management of the firms trading these instruments nor the credit rating outfits understood them. Little wonder the regulators were so easy to bamboozle. The Treasury Department plan requires a single regulatory agency to oversee too-big-too-fail firms and stricter regulation of non-standard derivative contracts. Good impulse: But how do civil servants keep a step ahead of financial engineers being paid a fortune to create the next generation of credit time bombs?

How do you eliminate skewed financial incentives? Existing bonus systems reward traders and financial executives who produce short term profits with no regard to long term risks. That could be fixed, but at the moment, compensation is in the hands of corporate boards of directors, not financial regulators. But as long as banks lavishly reward their top people for taking excessive risk then, guess what-they'll take excessive risks.

How do you foresee the next bubble? Some reform plans require the Federal Reserve to keep an eye out for "systemic risk." Others put the responsibility on a committee drawn from several regulatory bodies. But come on. If bubbles were easy to foresee and easy to back out of, they wouldn't happen in the first place. The idea that financial regulators have better crystal balls than anyone else is, to put it mildly, not supported by the evidence. But if not the regulators, who?

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