Issue of the week: Overhauling financial regulation

Rep. Barney Frank and Sen. Christopher Dodd are preparing legislation that would create a government agency tasked with regulating banks, insurance companies, hedge funds, and other financial firms.

While the nation is focused on congressional Democrats’ attempt to take over the health-care industry, said Investor’s Business Daily in an editorial, two New England liberals are readying legislation “that would squeeze the life from the whole economy.” Rep. Barney Frank of Massachusetts and Sen. Christopher Dodd of Connecticut, the Democrats’ point men for financial regulation, hope to create “an über-regulatory body” that would regulate banks, insurance companies, hedge funds, and any other financial firm deemed to be “systemically critical” and therefore “too big to fail.” This “monster” of an agency would have final say over the fate of troubled firms and could even order healthy companies to exit businesses deemed too risky. But “with politics comes favoritism,” and bailouts and preferences will inevitably go to favored firms. Such far-reaching regulation would be sure to “breed corruption, loopholes, lobbying, and the very kind of perverse incentives and distortions in the market” that led to Fannie Mae and Freddie Mac’s backing $1 trillion in bad loans.

If only the Democratic plans were that ambitious, said Mike Konczal in The Nation. On the contrary, the regulatory agency proposed by Frank and Dodd wouldn’t be strong enough to stop tottering financial firms from threatening the entire system. To be sure, Democrats want to create a mechanism through which “failures are cleaned up in an orderly and nondisruptive fashion.” But nothing in the plans would stop a financial firm from becoming so big and complex in the first place that its failure would set off a cascade of failures at other firms. Nor do the proposals offer any way to head off a failure except through a bailout—at taxpayers’ expense.

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