Just when I am applauding Representative Barney Frank’s clear, concise, effective new regulations for our financial markets that are designed to control previously unregulated investments - securitized debt, collateralized debt, mortgage backed assets, credit default swaps, and other derivatives - along comes Senator Chris Dodd to throw a wrench in the works. The issue is regulations, not regulators. Frank’s proposals address this. Dodd wants to create a new bureaucracy to oversee financial markets. In some respsects this parallels clamoring to cap bankers’ compensation when the real issue is transparency in trading these assets.
Let me try to explain this with a small example. Let us say that, instead of selling mortgages to an investor, a bank keeps them on its books. Say it owns 100 loans at $300,000 each or $30 million in mortgages. It now sees 3% of its mortgages in default and adjusts the value of its holdings to $29.1 million. Either the Federal Reserve Bank in the case of federally chartered banks or the FDIC in the case of state chartered banks can readily see the loss on the bank’s balance sheet and call for appropriate corrections.
If, however, the bank sells these mortgages as securitized debt it is hard to see how an individual holder’s mortgage holdings are affected by defaults, especially since these assets are traded on unregulated markets. This is what happened in the financial meltdown of last year that led to the current recession. Thus the solution for preventing a repeat is to bring these transactions into a visible market that allows transparency. When you do this it really doesn’t matter who is watching the business, be it the Federal Reserve or FDIC or whoever. Changing the regulator does not solve the problem, you need to change the regulations.
Amazing, when you have an effective, reasonably priced solution in hand, someone else has to come along with a high cost counterproposal, and believe me, creating a new government bureaucracy is very expensive, that does not do the job. Unfortunately the winner will be the one with the most political support, not necessarily the effective solution.