One thing is certain in this uncertain world: Once the currently roiled financial waters have calmed, the world of finance will not be as it was before the storm broke. There will be new rules, some helpful, others packed with nasty unintended consequences.
The first drafts of such new regulations are already on the drawing boards. The subprime fiasco has revealed an important market failure: Those granting the mortgages sell them off so quickly that they can be more than casual about the borrowers’ ability to repay — or even to make the first interest payment due.
Soon, mortgage brokers will have to retain some of the risk they have created. This will be forced on them either as a result of new regulations, or at the insistence of the investors that ended up holding these mortgages. We have probably seen the last of NINJA loans — no income, no job, no assets.
More fundamentally, it will be a long time before any presumption in favor of deregulation reasserts itself. For decades now, the vast majority of economists have argued that deregulation of financial markets has contributed to economic growth and to increased economic stability. That they are broadly right is no longer relevant. The hunt is now on for regulatory fixes — expanding the power exercised by the Fed to supervise banks and intervene in their affairs if necessary; more power for regulators to limit the ability of banks to conceal risks with a variety of off-balance sheet gimmicks; limitations on the ability of rating agencies to, in effect, “sell” AAA ratings pursuant to a system under which they are paid by those they are rating.
Nor will major financial institutions emerge from their current troubles unchanged. For one thing, their desperate need for new equity to offset the write-downs they have taken has thrown them into the arms of sovereign wealth funds (SWFs), nontransparent investment vehicles of national governments that might have other than purely commercial motives for intervening in the management of companies in which they are substantial shareholders.
These funds were the subject of much discussion at the gathering of the great and good in Davos, Switzerland, last week. Executives and Treasury officials urged the governments that control the SWFs to make their governance procedures and investment goals more transparent so as to avoid a political backlash.
My guess is that so long as U.S. banks badly need capital infusions from the SWFs, no one will insist on significant changes. Even one such as Chuck Schumer — the New York senator who opposed the Dubai ports deal — will swallow hard and allow his Wall Street constituents to take the money and run. But once balance sheets are in order and the need for cash is less urgent, pressure on these funds to change will become irresistible.
The rules governing monetary policy will also change. In recent years, there has been a debate over whether central bankers such as Ben Bernanke should focus solely on inflation in the prices of goods and services, or consider also prices of assets such as shares and houses. Former Fed Chairman Alan Greenspan and others argue that it is impossible to tell when there is a bubble that needs pricking, and even harder to do the pricking; it is better, they say, to leave to the market any corrections that prove to be needed, and clean up any mess the corrections create.
They have lost the argument, at least for now. The fact that the bursting of the so-called house-price bubble is complicit in the current, spreading problems means that in the future, attention will be paid to house and share prices.
Central bankers are now convinced that movements in asset prices affect consumer spending, job creation and inflationary expectations. So they won’t stand idly by while asset prices reach levels they consider unsustainable, but will raise interest rates or restrict credit to bring prices off the boil.
How they will know when investors have had too much of a good thing, I am not certain. But they will feel justified in intervening to dampen price rises, just as they are now called upon to moderate price plunges.
Robert Brand, a banker friend of the great economist John Maynard Keynes, once warned his pal against relying “on the skill and economic knowledge of bankers harassed by politicians.” Substitute “regulators” for “bankers” before cheering the new round o
Examiner columnist Irwin Stelzer is a senior fellow and director of the Hudson’s Institute’s Center for Economic Policy.
