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Regulatory Reform is Needed Now To Prevent The Next Bubble and Crisis

Like a pet ger­bil run­ning end­lessly on a cir­cu­lar wheel, Gov­ern­ment lead­ers are putting all of us on the eco­nomic tread­mill of ser­ial fail­ure. Calls for an imme­di­ate inves­ti­ga­tion into what went wrong and why are going largely unheeded as gov­ern­ment lead­ers claim that a witch hunt is the last thing we need now.

Well, I dis­agree. We need to hunt down the demons that tanked the econ­omy and exor­cise the sys­tem of the evil forces that have brought us down. I think that what is needed is a com­bi­na­tion of (i) imme­di­ate and aggres­sive enforce­ment of exist­ing law and reg­u­la­tion and (ii) a bi-partisan inves­ti­ga­tion of what needs to change so that there isn’t another bank­ing col­lapse dur­ing our lifetime.

By doing noth­ing the polit­i­cal lead­ers are set­ting us up to repeat the mis­takes of the last 5 years and guar­anty another cri­sis within a few years. Unfor­tu­nately, I have lit­tle hope of any­thing hap­pen­ing before the Pres­i­den­tial election.

Pol­icy mak­ers have set the global econ­omy up for a crash in a few years. They are rein­flat­ing the bank­ing sec­tor with mas­sive mon­e­tary and fis­cal stim­uli but not chang­ing the under­ly­ing sys­tem that was unable to deploy the rel­a­tively benign stim­u­lus that was pumped in after 9/11.

The Fed­eral Reserve has dropped the Fed­eral Funds rate to almost the post 9/11 level of 1.00% (cur­rently it is at 1.50%) and dra­mat­i­cally increased money sup­ply. It is also push­ing “qual­i­ta­tive” mon­e­tary stim­uli by using its bal­ance sheet to lend to banks, non-bank cor­po­rate bor­row­ers and other cen­tral banks. And, the largest Key­ne­sian stim­uli pack­age ever is being used to prop up the econ­omy. Ever since the New Deal ended pol­icy mak­ers have avoided fis­cal and mon­e­tary stim­uli on the scale that is being attempted by Paul­son and Bernanke. In the process of get­ting us out of this cri­sis they are cre­at­ing the con­di­tions for a mas­sive invest­ment and lever­age bub­ble start­ing in late 2009 and extend­ing into 2010 and 2011.

How­ever, the fun­da­men­tal reg­u­la­tory and over­sight sys­tem that enabled the 2007 bub­ble remains essen­tially unchanged. As exam­ples, there has been no mate­r­ial com­mit­ment on the part of the SEC to enforce laws and reg­u­la­tions, the Fed­eral Reserve still doesn’t act as if it is the pri­mary reg­u­la­tor of bank hold­ing com­pa­nies and, despite wide­spread and obvi­ous fraud, the Jus­tice Depart­ment hasn’t man­aged to indict a sin­gle senior mort­gage banker in con­nec­tion with bad mort­gages that caused the sub-prime mort­gage mess.

Con­ven­tional wis­dom states that the Bush Admin­is­tra­tion is “kick­ing the can down the road” on reg­u­la­tory reform and enforce­ment so that the next Pres­i­dent and Trea­sury Sec­re­tary will be forced to deal with the reform and enforce­ment prob­lem. Unfor­tu­nately, we don’t have the lux­ury of time to wait until the next admin­is­tra­tion takes office and learns its job. Unless the next Pres­i­dent has an urgent time­frame for action, as a prac­ti­cal mat­ter it will be the sum­mer of 2009 before reg­u­la­tory reform and enforce­ment will begin. And, by then the bank­ing sys­tem will be well on its way to inflat­ing the next bubble.

In less than 3 weeks either McCain or Obama will be Pres­i­dent Elect. I think that whichever can­di­date wins, his first order of busi­ness must be to appoint the next Sec­re­tary of Trea­sury and the next Chair­man of the SEC (Chris Cox has indi­cated that he intends to resign in Jan­u­ary, 2009). The tran­si­tion team must begin work­ing with Paul­son and his team imme­di­ately to get up to speed and begin the process of fix­ing the under­ly­ing issues in our finan­cial and cap­i­tal mar­kets system.

We must break the boom and bust cycle of the bank­ing sec­tor before it breaks us.

Posted in: Bernanke, Bush Administration, Chris Cox, Credit Crisis, economy, FDR, Finance, Fiscal Policy, McCain, Obama, Paulson, SEC

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