In: Root » » Loans and mortgages
The regulatory framework overseeing the nation's financial system needs a good overhaul. The current byzantine regulatory structure contributed to the subprime financial shock, allowing the most aggressive lenders to avoid regulatory scrutiny. Regulators were also hamstrung in efforts to impose greater discipline on the industry given the difficulties coordinating among themselves. Regulatory oversight tends to be pro-cyclical. That is, when credit quality is good and lenders are aggressive, regulators have difficulty imposing discipline; when quality is poor and lenders are tightening, the disciplinary screws are tightened. This tends to exacerbate shifts in lending standards and credit availability. In part it stems from regulators' inability to respond quickly, but it also reflects the influence of politics on regulation. Lenders find it much easier to keep regulators at bay when credit conditions appear robust, though this is generally when increased regulatory oversight would be most beneficial. The U.S. Treasury Department's "Blueprint for Financial Regulatory Reform," is a reasonable roadmap. In the wake of the mortgage debacle, the plan would establish a commission to create minimum licensing requirements for lenders and assess the caliber of state regulators. It would also give one regulator, probably the Federal Reserve, authority over mortgage lending laws, superseding all other federal and state regulators. In the long term, the Treasury's plan proposes consolidation of the current regulatory structure into three principal agencies. The basic concept of regulation would shift; instead of agencies monitoring specific types of financial institutions, regulators would specialize in various types of risks and activities. The Federal Reserve would look out for the stability of the entire financial system; its mandate would include any risk that threatened the system, whether it involved banks or hedge funds. The Fed is uniquely suited for this task given its central position in the global financial system, its significant financial and intellectual resources, and its history of political independence. A second regulatory agency would oversee any financial institution receiving an explicit government guarantee. Lenders couldn't choose their regulator as they do now and would have consistent standards to work with. The third regulatory agency would aim to protect consumers by monitoring how all financial institutions market their products. Financial institutions and their products no longer fit in narrowly defined boxes. The risks they take cut across markets and extend around the globe. The regulatory structure needs to adapt or it will be as irrelevant in the next financial crisis as it was in the subprime financial shock.
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