Supply-Side Financial Reform

Senate Democrats have tried for weeks to get Republicans to support the showpiece of their financial-reform package, a consumer financial-protection agency that would shield regular Americans from predatory financiers. But even the nimblest public agency cannot protect consumers from the biggest threat to their financial health: owing too much money. That threat will exist as long as the financial industry faces no ultimate market penalty—the consistent threat of failure—for lending too much too freely.

The proposed agency has a worthy goal. As Connecticut Senator Chris Dodd, who is leading the legislative effort with the White House’s support, sees it, the protection bureau would govern consumer financial products. Proponents, including economist Paul Krugman, say that such an agency could have helped America avoid the current crisis by prohibiting the most toxic mortgages.

But focusing on exotic products and fees misses the real problem: unfathomable debt levels. In the past quarter-century, the amount that families owe has risen more than sevenfold, from less than $2 trillion in 1984 to nearly $14 trillion, according to the Federal Reserve. Debt outran the cost of goods and services by nearly fourfold.

Many Americans can’t afford their debt unless their lenders use complex finance to suspend all disbelief. Exotic mortgage structures, then, were a symptom of the disease, not the disease itself.

How did it come to this? The financial industry has encouraged Americans to borrow so much because Washington has allowed the financial industry itself to borrow so much without consistent market consequences.

” But even the nimblest public agency cannot protect consumers from the biggest threat to their financial health: owing too much money. That threat will exist as long as the financial industry faces no ultimate market penalty—the consistent threat of failure—for lending too much too freely.”

I wonder if Nicole Gelinas is too young to know what the lending market was like before the last of Glass Steagall was scrapped around 1997.

In the not-so-distant past mortgage lenders wouldn’t loan you more than you could handle. They kept their own paper and stood to lose if the loan went sour. And if they did sell the loan it usually went to Fanny or Freddy, both of which would only buy conforming paper. Lending standards were therefore tight, due to the self-interest of the lenders. No outside regulatory agency was needed, other than the ones that made sure that banks followed Glass Steagall’s restrictions.

Well that all changed in the late 90s. Glass Steagall was scrapped and all sorts of financial innovation occurred, much of which removed the protections that we all took for granted. Lenders no longer kept their own paper, they bundled it and sold it off to investors. Lenders no longer cared if the borrower could handle the loan they offered. If it blew up, and took down the borrower and the holder of the note that wasn’t their problem. The economy at large would collapse if there were enough of those bad loans, but the loan originator would do just fine if he had the sense not to invest in the garbage he was generating.

At this point nothing has changed to keep lenders from going back to what they were doing during the bubble, other than that they have run out of suckers. They’ll have to wait for memories to fade and for a whole new crop of victims to come of age. But until we try to restore the protections we had with Glass Steagall the American economy is open to a repeat of recent events.

I was suspicious of the wisdom of scrapping Glass Steagall as well. Although I suspect that the number of us who even noticed it was small, since you really only knew what Glass Steagall was if you had some financial education.

“However, the author also has a point regarding debts, though”

To a degree. I didn’t see her mention the big change in the credit card market in recent years. Many states had usury laws that limited the rates that banks could offer, so they were more cautious about handing out cards. Banks began locating their card operations in states with no interest limits and they lobbied to be able to offer the cards everywhere. They also lobbied for and got a change in bankruptcy law that makes their loose credit policies less dangerous to their bottom line. That’s when you began to see them targeting college kids, with the result that many graduate with credit card debt that equals their college loans.

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