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Commentary

Franklin Delano Bush Pushes a Bad Idea


     
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By signing legislation creating Medicare Part D, George W. Bush became responsible for the most significant expansion of the welfare state since LBJ's Great Society. It turns out, though, that forcing taxpayers to help buy Granny's meds was the proverbial camel's nose of big Republican government. So what was next? The overhaul of financial market regulation announced recently by Treasury Secretary Henry Paulson, which, if adopted, would extend the federal government's reach more so than any policy initiative since the New Deal.

Intended to prevent recurrence of the turmoil triggered by the bursting of the housing bubble, the administration proposes to restructure the responsibilities of the agencies who now oversee U.S. financial market operations, in ways that supposedly would promote regulatory information-sharing, cooperation and coordination.

In an earlier crisis atmosphere, similar goals justified cobbling together the Brobdingnagian Department of Homeland Security, which just goes to show that, while interagency information-sharing and coordination sound good in theory, they are unlikely to be achieved in actual bureaucratic practice.

But the most troubling aspects of the Treasury's blueprint for reforming financial market regulation are found in the far greater powers it assigns to the Federal Reserve.

One part of the plan simply affirms actions the Fed already has taken.

Apparently concluding that Bear Stearns was too big to be allowed to fail, the Fed, for the first time in its history, granted to such non-bank financial institutions access to loans at its "discount window" — loans previously restricted to commercial banks — and guaranteed $29 billion in illiquid assets to broker Stearns's purchase by JPMorgan Chase.

So now that the Fed has lent those billions more to Goldman Sachs, Lehman Brothers, Morgan Stanley, and other Wall Street securities' brokers, the Treasury proposal would permit the central bank to conduct on-site inspections and impose conditions, including capital requirements, on such borrowers — which it now is doing without explicit authority.

And most worrisome, the regulatory reform plan also empowers the Fed to ensure "market stability," watching for threats originating anywhere within the financial system, be it from commercial banks, investment banks, mortgage lenders, hedge funds or insurance companies.

As economists have asked: if smart, highly paid Wall Street investment bankers with huge financial positions on the line failed to foresee the risk to which subprime mortgages exposed them, how can one expect a regulatory agency to do so? And, what steps will the central bank take to "stabilize" markets, if it does perceive a threat? Will it continue to bail out institutions who run into financial trouble?

The prospect of being rescued by taxpayers encourages risk-taking. So, transforming the Fed into a market-stability watchdog may create more market instability — not less.

To implement this plan, many new regulations would have to be written and costs would be imposed on financial institutions to comply with them.

In collaboration with Burak Dolar of Augustana College, I examined the costs of complying with USA PATRIOT Act's Title III, which required banks and thrifts to be more active in deterring money laundering and disrupting terrorist financing. While the law imposed substantial compliance costs on the entire financial services industry — $11 billion in 2002 alone — large institutions had two distinct advantages: they could spread the costs over greater numbers of customers and transactions, and many already had anti-money laundering procedures in place. In fact, rather than reinvent the wheel, regulators based their rules for PATRIOT Act compliance on the methods already in place — and in the budget — at the large financial institutions.

As a result, their smaller competitors were hit with disproportionate compliance costs draining as much as 20 percent of their profits.

Thousands of small banks and thrifts closed their doors in the following years, many after being bought out by bigger ones.

So, in addition to substantial growth in the federal bureaucracy, one likely "unintended consequence" of the Treasury's regulatory reform plan is greater consolidation of the financial services industry, creating more institutions too big to be allowed to fail and further erosion of the discipline essential to the operation of competitive markets.


William F. Shughart II is a Research Director and Senior Fellow at The Independent Institute, J. Fish Smith Professor in Public Choice in the Jon M. Huntsman School of Business at Utah State University, and editor of the Independent Institute book, Taxing Choice: The Predatory Politics of Fiscal Discrimination.

Taxing ChoiceFrom William F. Shughart II
TAXING CHOICE: The Predatory Politics of Fiscal Discrimination
So-called “sin taxes”—the taxing of certain products, like alcohol and tobacco, that are deemed to be “politically incorrect”—have long been a favorite way for politicians to fund programs benefiting special interest groups. But this concept has been applied to such “sinful” products as soft drinks, margarine, telephone calls, airline tickets, and even fishing gear. What is the true record of this selective, often punitive, approach to taxation? Learn More »»






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