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Dr. Becker and Judge Posner hit the mark. This "financial reform" legislation illustrates what children with matches may do when unleashed in the dynamite shack.


Judge Posner, I take issue with some of your points.

1. At first your point that consumers were not victims seemed wisely dispassionate considering the popular mood, but, upon closer examination, I would like clarification. Given that credit is the lifeblood of this economy, it would seem to me that the wiping out of a vast swath of our population's credit histories as a result of fraudulent lending practices would seem a worthy goal to alleviate. No doubt, their inability to get affordable financing has contributed to the unemployment rate through lower aggregate demand. And while I agree portions of the regulation may overreach, isn't the purpose of much of the financial regulatory establishment to alleviate asymmetric information and moral hazard issues?

Also, I respectfully think that calling the banks victims is a stretch. As a result of deregulation ballyhooed for the "choices" it allowed banks for financial innovation, they "chose" to invest in assets peddled through opaque, over the counter dealers that wrecked their balance sheets. While hindsight is twenty-twenty, the facts of the past were once someone's present and the incentives of the manager's making Structured Investment Vehicles and selling securities backed in part by loans to trailer park communities were to enrich themselves while putting the system at risk. To be more concise, I highly doubt that the traders close to the market didn't know they were selling economic poison that could enrich them in the short term so it seems incorrect to attribute victimization to the banking industry.

2. I agree with much more of this, but your point on monetary easing seems intellectually dishonest. It was a godsend that monetary easing could go down to the zero bound at the bottom of the crisis rather than before given that contagion was the the crisis' cause not anything rational about economic fundamentals. If monetary easing had been done earlier, far from averting the crisis, it would probably have just given the country one less policy tool to use.

3. Agreed

4. Mostly agreed.

5. Uncertainty seems to be a theme of the freshwater economist's economic explanation of the last 2 years. The way some conservative economists talk, it's as if employment is not rising and investment spending is down because of the "uncertain" environment Obama has created. While I do not deny there are likely statistically significant macro effects of the onslaught of regulation over the past 2 years, as an entrepreneur, I can tell you that I don't care a bit about tax rates. In fact, I actually immensely benefit and can continue my startup (and hiring) because of a provision in the healthcare bill. All of this nonsense about uncertainty causing 10% unemployment and firm's hoarding trillions in reserve because of government uncertainty is utter nonsense. They're holding cash because they've got excess capacity as it is because there isn't any demand for goods, which, as a tech entrepreneur, I can tell you is a bigger deal to my margins than some voodoo uncertainty caused by government.

Thank you for your ever incisive commentary.

Ross Anderson

Professor Becker

I'm one of those who have urged the Fed (and other regulators) to pay attention to consumer protection. The link with the credit crunch is simple enough: just as regulators credulously believed the banks' assurances about their credit risk management, so also they believed the banks' assurances about operational risk management. And if bank regulation is to be overhauled, regulators should be tasked with considering all systemic risks, not just the risks that led to the most spectacular recent failure.

Colleagues and I study fraud, particularly against card payment systems and online banking systems (see for example http://www.lightbluetouchpaper.org/?s=banks ). Fraud losses are rising worldwide; victim surveys show online fraud displacing burglaries and vehicle thefts as the main form of acquisitive volume crime. There are at least two causes.

First, online crime is global; the police are more willing to investigate a burglary at your house, whose perpetrator is probably in Chicago, than a fraud against your credit card, whose perpetrator is increasingly likely to be in Lagos or St Petersburg. Our mechanisms for international mutual legal assistance were designed for rare, high-profile criminals like Dr Crippen - not for high-volume low-value offences. So online crime is a high-reward low-risk activity; the perpetrators are often the smartest people in the poor countries, not the dumbest people in the rich ones.

Second, banks worldwide exploit captured regulators to play liability games. The cost of fraud is increasingly being dumped on merchants, on customers or on both, depending on local law. The effect is that the banking industry - which has the ability to improve the security of the payment system - does not face the full social cost of its failure to do so. In countries where liability shifting is easy, we not only see a steep rise in fraud; the terms under which merchants can acquire credit card transactions also become unattractive, making such countries less competitive as a domicile for firms doing business online worldwide. So there is a systemic risk from, and a national interest in, bank customer protection.

That said, the USA has probably the best customer protection of the major economies. I would be delighted if the European Central Bank, or the Bank of England (when it takes over from the Financial Services Authority), were to be as vigorous at protecting consumers as the Fed already is.

From discussions with Fed officials, I gather that market concentration is leading to rising interchange fees, which are being used to shift liability for fraud from acquirers to issuers. I am happy to defer to their expertise about the markets they regulate. In addition, the Fed will soon have to take a decision on whether to allow US banks to deploy the EMV "Chip and PIN" card payment system that's used in Europe and is currently being rolled out in Canada. That has been bad news for both customer protection and overall fraud levels, as it was engineered from the start to facilitate liability shifting. (If you dispute a transaction with your bank, then if a signature was used the bank blames the merchant; if a PIN was used, the bank blames you.) I can well understand the Fed's desire to have regulatory tools to cope with the likely consequences. And if there's only going to be one bank regulation bill this decade, it's quite rational for the Fed to use it to acquire the powers it feels it needs.

Finally, from a philosophical viewpoint, regulators should not be tasked with protecting the banks, but protecting the customers. I fully accept your point that regulators are often captured as a practical matter on issues that outsiders don't care about. However, rising fraud levels ensure that customer protection won't be one of those issues. Interests from law enforcement through consumers' associations to large firms like Microsoft and Google are all starting to care very much about online fraud.

Ross Anderson
Professor of Security Engineering
University of Cambridge

Brian Dolby

Just a comment on the credit/debit card transaction fees. Presently these fees are deliberately hidden from the consumer by having the merchants pay them. The problem with the current method of paying transaction fees is the consumer has no real idea of what actual cost of using credit/debit cards is and there is no real competitive spirit of the credit card companies to hold down the amount of fees being charged. I say the transaction fees should be charged and added to the sale at the time a purchase is made. The consumer would know right then the actual cost of using credit/debit cards to make purchases and thus be compelled to shop around for a competitve card service. The merchant would not have to add these costs to products/services being sold and cash customers would not be subsidizing transaction fee cost of card companies through increased pricing of products/services that merchant do to make up for the transaction fees they now pay monthly. Typically 7-9 cents per gallon of gasoline is added to cover these transaction fee cost. Cash customers presently pay this. Also-the fees charged are in percentage of sale not a flat fee as it should be. By having the consumer pay up front the transaction fees at time of sale this likely would change. The card companies take in roughly 48 billion dollars per year in these transaction fees-money hardly earned. I urge those interested in this matter to call upon their senators to correct this.


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In response to the five issues surrounding the current pending "Financial Reform Bill" as listed, the Bill is trying to deal with three fundamental issues that have occured within the modern Financial Industry and Consumer based economy, not just dealing with the issues that lead up to the current Financial Crisis. Those three issues are:

1. "Usury" in it's modern and varied forms.

2. The problems inherent in "Shadow Banking" and the creation of exotic financial instruments.

3. Federal Regulatory Agency fears of oversteeping its regulatory authority and bounds which leads to "inaction" at critical junctures in the midst of crises.

But do too the problems inherent in Representative based legislative process's (the problems of ideological quirks, excessive lobbying and compromise), we've ended up with a sausage instead of filetminon. Although, the Bill is not perfect, at least it's a move in the right direction. Hopefully.

Gordon Longhouse

Regarding what Brian Dolby had to say about credit card fees, in Australia the central bank (the Reserve Bank of Australia) has regulatory responsibility for the payments system (though not for the prudential regulation of banks).

Some years ago the RBA noticed that the more costly payment system -credit cards- were being used in preference to the cheaper system: debit cards. This was a result of banks enticing credit card use with rewards programs while merchants were contractually unable to pass on merchant fees they were charged for credit card use.

To correct this anomaly the RBA made a rule prohibiting credit card companies from insisting that merchants not charge extra to credit card use.

The result has been that some, not all, merchants (and all taxi cabs) charge for credit card use: usually a modest fee. Airlines and movie houses charge outrageous fees for credit card use on internet sales. In fact for Australian airlines, the accounting dept. has become a major profit centre.

Supposedly you can use debit card feature to avoid these fees (this is a legal requirement) but the obstacles are so many that most don't even try.

I believe that some large chains were able to re-negotiate their merchant fees but these deals (if they exist) are kept commercial in confidence.

All in all it is difficult to discover if this reform has brought about the desired outcome -more debit card use - or not though the RBA has ceased to sound off about the topic which may mean something.


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The issue with your analysis is this: if you only solve what caused the crisis, you are setting yourself up for the next one. You need to be able to foresee what could cause the next one and act to prevent that. That is the flaw with your argument.


My primary concern with most, if not all of the proposals in the FinReg bill is that the entities it proposes to regulate/legislate pretty-much always have, and likely always will be smarter/better/faster than the regulators/legislators.

Force "originators" (haven't read the bill in full-text, not sure how this is defined, but I'd imagine vaguely, at best) to hold x% (in this case semi-arbitrarily 5%) of loans originated? I'm quite certain it won't be difficult to reorganize a lender such that any undesired losses on withheld loans won't (have any material) effect on the parent company's financial statements.

The other issue, which I've brought-up ad nauseum, is the issue of the incentives we give regulators/legislators to effectively do their jobs, in this case, create and enforce policies that should limit the pain we suffer from future economic bubbles and the inevitable collapse that follows.

How on Earth does anyone expect some 2nd or 3rd-rate Lawyer @ the SEC with zero financial or economic experience (or training) making a flat $130,000/year to outsmart a top-rate (or at least likely higher-caliber) economic/financial/legal mind on Wall Street making 5, 10+ times as much?

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Regarding point (4), one of the terms in the note purchase agreement provided for the gradual winding down of the housing agencies.

"5.7. Mortgage Assets. Seller shall not own, as of any applicable date, Mortgage Assets inexcess of (i) on December 31, 2009, $850 billion, or (ii) on December 31 of each year thereafter, 90.0% of the aggregate amount of Mortgage Assets of Seller as of December 31 of the immediately preceding calendar year; provided, that in no event shall Seller be required under this Section 5.7 to own less than $250 billion in Mortgage Assets."

See page 9 of http://www.treas.gov/press/releases/reports/seniorpreferredstockpurchaseagreementfrea.pdf

Assuming this provision is followed, we don't need future legislation dealing with these agencies -- their winding down began the day they were taken over.

Jeremy Weinstein

I think you've missed the most damaging provisions of the bill. The bill changes rules concerning margin posting by derivatives users seeking to hedge their business exposures. Users are herded onto exchanges that not only are imperfect hedges, but require full margining. In OTC transactions, there is usually a multi-million dollar threshold with each counterparty below which margin need not be posted- so every business loses a couple of hundred million dollars in trading liquidity- multiply that across every US business.

Also, dealers are effectively prevented from rehypothecating collateral posted to them. If OilCo hedges production with Bank, and Bank hedges fuel with Utility, right now Bank uses OilCo's collateral posting to it to post the collateral it owes to UtiliCo. The blll effectively prevents that. This means that banks will either exit the business or they will charge that capital cost to their endusers.

So, if Southwest hedges the cost of jet fuel less because of the capital cost of doing so (because it needs margin or is charged margin costs by its counterparty bank), or its cost of hedging is made more expensive because the banks will charge it the cost of capital on the protection it has achieved, you are going to be seeing that in ticket prices.

Thus, there are economic savings through collateral posting requirements- maybe a trillion dollars worth or more. To the extent there are not savings, because there are not hedges, then the volatility we saw in commodity pricing before these instruments were widely used, will return. So, if congress was wondering how to return us to stagflation, they've hit upon the answer.


I learned in Kindergarten that if something doesn't make sense, 99.9 percent of the time it doesn't make sense. All of this "rehypothecating" doesn't make sense. It's all about "Transparency" or the lack thereof. Which got us into this Financial Crisis in the first place. Sounds like a "Shell Game" too me and at the Carnival level these are controlled by Law and have been for ages.

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Good legislation should diminish the need for more compexity and uncertainty. Need I say more. I feel sorry for my children and my grandchildren.


I'm a little unclear. If Freddie and Fannie owned all the sub-prime mortgages, then what was in all those mortgage backed securities being sold on wall street? Chopped liver?

Leroy J

The article poses an interesting view, but it doesn't address issues of future reversions. It's simply more of a band-aid on a more disastrous problem. There's a compelling piece from another blogger who frames the issue of future prevention well, in my opinion, framed in an analysis of the Goldman Sachs debacle: http://lawblog.legalmatch.com/2010/05/18/dissecting-the-goldman-sachs-fraud-lawsuit/


And so ... the 2300 page Financial Reform Act has become a "fait accompli". I wonder how long it will take the "Wall Street Sharpies & the K-Street Sharpies" to figure how to circumvent it like they did the last set of regulations. As the old saying goes, "If the Law doesn't have teeth, it's not much of a Law".

John R. Thomas

I think your analysis of this bill is right on, it was more a political move than any real desire to help consumers. From mortgage lenders point of view, they have hurt the consumer with the new stipulations they are putting on loan originators. The bill will make it even harder for brokers and correspondent lenders to compete with the federally regulated banks who are already exempt from all teh licensing requirements that have been put in place. The end result will be consumers having to work with hourly employees at big banks who will only do easy loans because their is no incentive to work with a client who has many challenges to overcome in order to qualify for a loan.

John R. Thomas
Certified Mortgage Planner
Primary Residential Mortgage, Inc.

Jack Walton

The most worrying aspect of this bill is the power granted to the Federal authorities to seize and liquidate an entity (not necessarily a financial entity) if it is deemed to pose a systemic threat to the financial system. What they've done is overlaid the "log-normal" world of optionality with a big binary! Who is going to buy equity from a bank which has hit a few speed bumps if there is even a remote possibility of the Fed's exercising this option. Perhaps some enterprising grad student could get a journal article out of the analysis.

I find that Treasury Secy Geithner's knowledge of probability and statistics to be woefully lacking. There's as much risk owning a 30 year treasury security as there is owning a secured revolving credit issued to a Ba3 rated company.


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If Fannie and Freddie are eliminated, who would take their place to free up cash?

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