Thomas Oliver: Financial reform misses the point

By Thomas Oliver

The Atlanta Journal-Constitution

Politically manufactured disasters always result in politically motivated reform. And the reformers aim to avoid responsibility while pointing to a scapegoat and praying for a gullible public.

The Financial Panic of ‘08 was primarily the result of bad economic policy. Namely that everyone should own a home.

The financial reform bill working its way through the U.S. Senate doesn’t even address that issue, or the two main institutions that underwrote that policy – Freddie Mac and Fannie Mae.

Of course the bill does reflect the misconception that the financial fiasco occurred because of a lack of regulation.

For anyone to seriously suggest we didn’t have regulation or tough enough regulators is to deal in deception or to buy into demagoguery.

We had regulations. We had regulators. They were holding bankers' feet to the fire to lend more often to less credit worthy customers.

Washington even supplied the financing mechanism to underwrite this push into subprime – namely Fannie Mae. Congress pushed and pushed, and lo and behold, our creative geniuses on Wall Street figured out a way to finance bad policy.

Bad policy promotes risky financial instruments. If it were sound policy, there wouldn’t be any need for risky, shaky, even shady financial instruments.

“We pointed a gun at the banker to make a loan to this person and when that person can’t pay it back, we call the banker irresponsible,” says Dorsey Farr, a former Fed economist, now principal in Atlanta-based investment firm French Wolf & Farr.

The reform bill and its summary seem to say all the right words regarding too-big-to-fail:

"As long as giant financial firms (and their creditors) believe the government will prop them up if they get into trouble, they only have incentive to get larger and take bigger risks, believing they will reap any rewards and leave taxpayers to foot the bill if things go wrong.”

There is considerable debate whether this bill will eliminate too-big-to-fail or simply institutionalize it.

You don’t have to be a cynic to believe the latter. You just need to understand that the bill turns the many complex assessments involved in whether an institution should be propped up or shut down by the FDIC or sent into bankruptcy court into a political decision.

Therein lies the problem.

The same problem that turned a financial crisis into a worldwide panic and a recession into the worst economic collapse since the Great Depression.

Much of the conventional wisdom states that the fall of Lehman Brothers in September 2008 set off the financial panic that froze credit and resulted in the unprecedented TARP program.

Hence the term “systemic risk” and the notion that some firms’ failures might set off a systemwide catastrophe.

However, Stanford economist John B. Taylor demonstrated early on that it was not Lehman Brothers’ bankruptcy per se that set off the financial panic but rather the uncertainty created by government action, which earlier had saved Bear Stearns and then the day after allowing Lehman to collapse, stepped in and saved AIG.

This uncertainty culminated in Ben Bernanke's and Henry Paulson’s initial request for $700 billion in emergency funding that became TARP.

Remember that disastrous presentation to Congress and the infamous two-and-a-half page bill that had no limits on how the money was to be used?

At that point, a week and a day after the fall of Lehman, the financial instruments that gauge risk went off the charts and the credit markets froze, according to Taylor’s research.

Farr says that until Bernanke and Paulson went to ask for congressional help, the yearlong crisis had been handled outside the political process.

“But when we entered the political process, at that point, all bets were off,” Farr said. And that set off a crisis in confidence.

One we still suffer from.

Thomas Oliver writes the Sunday business column. He can be reached at toliver.writeright@gmail.com