The Grist Grinds Slowly--Pt. I

The cracks in the Republican Senate filibuster against the financial reform bill are timely and welcome. The legislation has been carefully considered and mostly does what it needs to do. The Republicans found themselves in an impossible position politically, because they did not have popular support for their obstructionist program on this issue, and furthermore their objections were incoherent. They recognized the need for the reforms and accepted most of the bill, arguing around the edges, but that couldn't hold together long a united front against even considering the bill on the floor.

Refloating the Titanic

A couple of notes on critical pieces of the craft of putting our unwieldy boatload of bucks back above water: the biggest hole yet unpatched is the lack of any reform of the credit rating agencies. Their business model was thoroughly exposed in the last crisis, and their ratings (at least for complex financial packages) lack credibility. Buyers today must do their own homework, which in the cases of these synthetic, derivative-based products is hugely difficult--by design. I see an opportunity to make a private business supporting the evaluation of mortgage-backed securities, and the logical place for it to develop would be either in the credit bureaus themselves, or in Fair Isaac, the credit score developer. These are organizations that are competent to deal with the mass of data (and mortgage data in credit bureaus has been improving steadily).

The $50 billion bogey--a fund built to "pay for the funeral expenses" of big financial institutions which must be closed down, sometime in the future--is negotiable, certainly in the amount, but the concept makes sense. The FDIC has shown it can close down the smaller banks, but the scale of the large institutions would overwhelm its budget (and threaten to drag down the support for all the banks). That scale can't be provided through normal appropriations, either, because they are too slow, when what would be needed must be quick, firm, and even confidential (to avoid panic). It makes no sense to pretend that there are not significant expenses involved, and it is important to emphasize that the funds may not be used to repay creditors and shareholders (which was done in the bailout).

The key aspect of the reform is the requirement to make derivatives trading public, and because that is included in the Dodd bill (at Obama's insistence), the whole thing is worth passing. My most fundamental criticism, though, is that the legislation is fighting the last war. Questioning of the bill's designers and economists always seems to focus on the question, "Would this bill have prevented the last crisis?" and, after some struggle, it seems that they can now confidently say that it would.

Unfortunately, though, that is not likely to be good enough to deal with the next financial crisis, which will come from a new, currently exotic direction. It is still too early to see the dimensions of that future iceberg, which we can only hope means it's not yet on the horizon. That doesn't mean though, that there shouldn't be some thought on the question--something also not apparent; perhaps a new, more forward-looking bill could be developed in the next year or two, along with something putting ratings agencies on the hook for their ratings and with requiring mortgage lenders to hold onto some of their bookings from here forward.