Tags: investment | banks

Former Reagan Adviser: Bad News for Taxpayers

Monday, 28 Jul 2008 12:02 PM

The recent memorandum of understanding between the Fed and the SEC is "very bad news for U.S. taxpayers," according to Peter Wallison, a former White House counsel for President Reagan.

"This will irretrievably compromise market discipline," he writes, "which in turn will produce the very risk-taking and subsequent losses that regulation — as recently as the savings-and loan-debacle — has never been able to prevent."

Under the agreement, the SEC will provide financial information on investment banks to the Fed, improving its new-found ability to rescue those companies.

The agreement, an end run around Congress, will "pave the way for vast new U.S. government liability," writes Wallison, now resident fellow at the American Enterprise Institute, in the Financial Times.

Investors will justifiably believe the government will bail out big investment banks.

Democratic Sen. Chris Dodd, chairman of the Senate Banking Committee, and Sen. Richard Shelby, its ranking Republican, asked the Fed and SEC to leave the job of assigning regulatory roles to Congress. The agencies ignored the senators, Wallison charges, essentially giving a green light for the agreement between the Fed and SEC.

And the agreement lacks a time deadline, Wallison points out. Instead of a one-time response to a single crisis, expanded Fed powers are indefinite.

If Congress wants a say, it should act now, Wallison urges.

The Fed gains greatly expanded authority under the agreement. Meanwhile, the SEC, chastened by the Bear Stearns collapse, is greatly weakened.

"I think the Fed has established a menu of things that will give them much more power than they've ever had before," Wallison told Forbes. "Why waste a good crisis?"

Significant policy changes are only warranted if the financial market has clearly, substantially changed, says Wallison states, and it hasn't.

Some argue this situation is different because credit default swaps (CDS) make the market more interconnected, so an investment bank failure might cause a market-wide collapse.

Not true, Wallison argues. CDS don't increase overall risk. Like insurance or performance bonds, they only transfer risk from one party to another.

Unwinding a Bear Stearns failure would have been complicated, he says, but that's a reason to set up a clearing house for swaps, not to regulate investment banks.

"Moreover, unlike commercial banks, investment banks are unlikely candidates ever to cause systemic risk," Wallison states.

Investment banks collateralize their borrowings. If they fail, creditors can usually sell the collateral. But commercial banks can leave depositors and others without funds. That's why large investment banks may be too big to fail.

"Applying the too-big-to-fail label to investment banks reflects a serious misunderstanding of how their business model differs from that of a commercial bank," Wallison charges.

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The recent memorandum of understanding between the Fed and the SEC is "very bad news for U.S. taxpayers," according to Peter Wallison, a former White House counsel for President Reagan. "This will irretrievably compromise market discipline," he writes, "which in turn will...
investment,banks
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2008-02-28
Monday, 28 Jul 2008 12:02 PM
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