In laying the intellectual foundation for the Obama administration's proposed overhaul of financial regulations, Timothy Geithner and Larry Summers rightly point out that "basic failures in financial supervision and regulation" contributed to our current predicament. That phrasing is exactly right—but they then jump in exactly the wrong direction. They presume that the failure of supervision and regulation was a result of inadequate power, rather than the lack of will to use existing power. Their conclusion, therefore, is to seek a grant of additional power rather than to question why those who had it didn't use it.
This distinction is important, because if we misunderstand the history of the crisis, we will learn the wrong lesson. Washington loves to pass new laws conferring additional power whenever there is a major mishap or crisis. Doing so implicitly confers immunity on those who were in power at the beginning of the crisis by sending the following message: The appropriate authorities did not have the power to forestall this problem. But now that we have granted new powers to these authorities, they will avert the next crisis. The problem with this grant of immunity is that we then fail to ask why no one used the power they had and whether rigid ideological thinking got us into the crisis in the first place.
Each of the major regulatory steps that the Treasury secretary and the director of the National Economic Council have set forth makes eminent sense. Yet each was already squarely within the purview of an existing federal agency. The essential prongs of the reforms are:
• To raise capital and liquidity requirements for the most interconnected entities and use the Federal Reserve to ensure against excessive "systemic risk." But every major institution whose lack of capital posed a systemic risk in this crisis was already within the jurisdiction of a major federal agency—the Fed, the Comptroller of the Currency, the Office of Thrift Supervision—that had the capacity and obligation to oversee the financial stability of that organization. One might even argue that nothing is more central to the core mission of the Fed in particular than to limit the systemic risk running through the financial sector. Its own Web site repeatedly speaks to its obligation to ensure the stability and soundness of the financial system. So why did it fail to do so?
• To rationalize securitization by requiring additional disclosures and expanding supervision of the highly suspect rating agencies while also expanding the reach of regulation of derivatives. The Securities and Exchange Commission already has direct oversight of the rating agencies, yet it never effectively used it. And the critical decision-makers over the past several years, in a now well-told story, specifically rejected the use of their authority to impose greater regulation on derivatives.
• To expand consumer protections in an array of financial product areas, from annuities to predatory lending to credit cards. Again, the SEC, OCC, and the Fed had more than enough power to do this. In fact, even though federal agencies were doing precious little to protect consumers, they went to court and to Congress to stop states from doing much of this, claiming that states were treading on exclusive federal domains.
• To create a better long-term alternative to Fed lending to avert the failure of bank holding companies. True, an FDIC model may allow for greater flexibility. But the Fed was able to conclude every bailout in an orderly fashion, and the lack of an alternative did not in any way contribute to the crisis.
• To begin to integrate international efforts, given the globalization of finance—something that Treasury and the Fed had been doing for the past decade.
The proposals are useful, even worthy. But their absence had virtually nothing to do with the reason the crisis developed. Each so-called additional regulatory power was already within the reach of the agencies.
The reason to focus on this is to ensure that we ask the appropriate question: Why did the government fail to use the power it had? Maybe the answer is that the ideology of the moment simply ran counter to the aggressive intervention that was called for, and we have now learned a costly but valuable lesson. That would be fine. Maybe the answer is that the wrong people were in charge of the agencies, and in the new administration the right people are in place. That would be wonderful. But we should not fool ourselves into believing that the government didn't have this power in the first place.