regulatory reform

 One year after the Wall Street meltdown, President Obama is touting new regulations he says are urgent for preventing a crisis like this from ever happening again. 

 “Obama challenges Wall Street to support his regulations,” reads the headline of a story from McClatchy Newspapers on Obama’s Monday speech at Federal Hall, opposite the New York Stock Exchange. In the address, Obama asked the audience of Wall Street traders ”to embrace serious financial reform, not fight it.”

But “embracing” Obama’s planned regulation may be easier for the Wall Street audience than meets the eye. This is beause a closer look at new rules Obama is proposing shows that the bulk of them do not go after the Wall Street culprits, but instead Main Street entrepreneurs that had nothing to do with the crisis.

The regulatory “white paper” issued by the Obama administration in June would shower mounds of red tape around job-creating venture capital firms, discount brokerages and the small investors who use them, and the limited banking operations of everyday businesses from discounter Target Stores to motorcycle maker Harley-Davidson.
 
Meanwhile, many of the flawed government policies at the root of the crisis from government-sponsored enterprises Fannie Mae and Freddie Mac to mark-to-market accounting mandates still have not been fully addressed. He should go after these reforms rather than putting in rules that would burden legitimate investors and entrepreneurs.
 
Among the mandates in Obama’s regulatory reform that would hit Main Street are.
 
1.    The forcing of businesses such as Target and Harley-Davidson to sell off their limited banking operations, or industrial loan corporations
 
For decades, nonbank businesses have been able to set up limited banking operations to issue credit cards and make loans to consumers. These operations, called industrial loan corporations (ILCs) are subject to most of the same as well as some more stringent rules for safety and soundness. Some of the most respected businesses, including Target Stores, Harley-Davidson and Toyota Motor, have set up these ILCs to help lower costs for consumers. Even House Financial Services Chairman Barney Frank recently told Bloomberg News that these weren’t a factor at all in the financial crisis — rather the big banking conglomerates were.

Yet Obama’s plan not only continues the unwise moratoriums on new ILCs it would force the existing one to be dissolved or sold off. As Coleman Drake and I write in the Washington Times, such a drastic action could have a dramatic effect in reducing access to credit and jobs in a still fragile economy.
 
2.    Putting an “investment adviser” fiduciary duty on discount brokerages that serve self-directed investors.
 
The Obama plan would put a “fiduciary liability” on many brokerage firms equivalent to the current standard on investment advisers. Many brokers would have to guarantee that investments are “suitable” for certain types of investors and be sued if they are not. But the hallmark of many discount brokers such as Fidelity and Charles Schwab Corp is that many of its customers don’t really want investment advice. They are self-directed investors make their own decision what to buy and sell, and then trade and click on their laptops.
 
Yet the fiduciary standard of care in Obama’s plan could apply even to advice incidental to trading – such as discount brokerage call centers. Charles R. Schwab, the founder of the firm that bears his names and has taken on old-line brokerages to provide discounted trading to individual investors, warned in a Wall Street Journal op-ed that the logical outcome of this mandate “would be that individual investors would be constrained to a small set of plain-vanilla investments – Treasuries for all – or would be forced to pay us a fee to manage their account.”
 
This rule would also miss the mark in terms of preventing fraud. It does not go after those who clearly offer investment advice. Bernie Madoff was a registered investment adviser, yet he passed SEC examinations with flying colors. This could also have the unintended effect of investors doing less due diligence on their investments, which could leave them at greater risk.
 
3.    Venture capital firms could be subject to mounds of regulation for the “systemic risk” they have not been shown to contribute to:
 
Under broad regulations proposed for hedge funds, other investment pools for sophisticated investors could be burdened with red tape. Among these are venture capital firms of the type that gave the crucial seed money to Apple, Google and other Silicon Valley startups that are now among today top tech firms. And these pose less risk than many other investment vehicles.

As James Freeman has written in the Wall Street Journal, “Even if one wishes to be paranoid about systemic risks, it’s hard to imagine how tiny tech companies could be ground zero in a future credit bubble. Fannie Mae and Freddie Mac don’t provide cheap financing to VCs.”
 
Conclusion: Wall Street deserves a lot of blame, but so do outdated big-government policies from Washington that were going strong despite the myth of the era of deregulation (I’ve outlined the main factors in this article that ran in Stocks, Futures & Options magazine.).

As CEI President Fred Smith has long urged, President Obama and Congress should sell off and break up the government-backed Fannie and Freddie, which new research shows were not only buying subprime mortgages directly but labeling other subprime mortgages as prime.

They should continue the progress in reforming mark-to-market accounting, which exacerbated the crisis by forcing financial firms to mark down even performing loans and lose capital to lend with. The small mark-to-market reforms put in place in April of this year have helped bring stability back to the banking sector, but the quasi-private Financial Accounting Standards is threatening to re-impose the flawed standard, something lawmakers need to stop.

Also, policymakers should pare back the costly Sarbanes-Oxley Act of 2002, the accounting mandates of which did virtually nothing to prevent the financial crisis and are now preventing smaller firms from going public to get the financing they need to build new businesses and new jobs.
 
Policymakers should observe the anniversary of the meltdown on Wall Street by pursuing pro-growth policies that will lead to a rebirth of entrepreneurship on all American streets.